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SMAs Grow Despite Competition, Oversight

Separately managed accounts (SMAs)are no longer the new kids on the block, but they continue to grow at a steady pace. Assets in SMAs have nearly doubled over the past five years, to $774 billion

Separately managed accounts (SMAs)—sometimes called wrap accounts or individual managed accounts—are no longer the new kids on the block, but they continue to grow at a steady pace. Assets in SMAs have nearly doubled over the past five years, to $774 billion in the second quarter of this year, up from $400 billion at the end of 2001, according to the Money Management Institute. And despite stiff competition from rival products like exchange-traded funds (ETFs), as well as more rigorous oversight by regulators, that pace of growth is expected to accelerate.

Assets in SMAs are forecast to grow at a compound annual rate of 18 percent over the next five years, up from around 14 percent over the past five, according to Boston’s Financial Research Corp. That trumps the projection for mutual funds, which are expected to grow at a 10 percent clip over the next half decade. (Mutual funds still have a sizable advantage in total assets under management with $9.3 trillion.)

“Distribution firms shifting toward fee-based revenue models, the desire of advisors to provide a higher level of service and customization for high-net-worth clients, and high balance IRA rollovers will drive growth in SMAs,” FRC analysts wrote in a recent research report entitled, Where the Asset Growth Will Be 2007-2011. Another boon for SMAs is the recently passed Pension Protection Act of 2006, which allowed for SMAs to be included in 401(k) plans.

And yet, SMAs have some tough competition. FRC analysts expect asset growth in ETFs, 529 plans and hedge funds to outpace asset growth in SMAs, in percentage terms, over the next five years. ETFs are expected to post a five-year compound annual growth rate of 29 percent, bringing total assets to roughly to $1.4 trillion by 2011, while 529 college savings plans are expected to grow at a compound annual rate of 24 percent, to $258 billion, and hedge fund asset growth is pegged at 19 percent for the period.

Because of their growing popularity, SMAs are also—increasingly—in regulators’ sights. They face suitability, trading, record-keeping and compensation issues as well as a debate over whether they should qualify as “investment companies” for regulatory purposes.

One issue that regulators have expressed concern about, for example, is that many money managers send all of their trades to the SMA provider or “sponsor,” even though they have the freedom to trade away. Regulators worry that managers may not be making sure they get best execution, says one former SEC attorney.

Some critics argue that SMAs are too expensive for investors, not profitable enough for money managers and that their tax and customization features go largely unused. Further, there are ongoing technology challenges related to linking money managers with the various legacy systems at sponsor firms and other operational difficulties that make SMAs costly and cumbersome.

But these concerns don’t seem to have deterred growth in SMAs yet. “From a marketing and product standpoint, they’re very attractive,” says Lauren Bender, manager of the retail securities and investments practice at Celent, a Boston-based financial research and consulting firm. “There are going to be profitability challenges. Many of the money managers managing the accounts are working with three, four or five different platforms. It’s hard to make money. If they were managing the same amount of assets on one system it would be different.”

Still, Bender says that the advantages of SMAs outweigh the potential regulatory pitfalls and structural shortcomings. “It’s an easier product to sell and administer” than individual securities or mutual funds, she says, because the client can have all his assets under one umbrella for a fixed fee. “It vastly increases the advisor’s reach,” she says.
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