Despite Vaunted Expectations for separately managed accounts, the traditional SMA is not turning out to be the magic bullet Wall Street firms would have you believe it is. For starters, SMAs are not appropriate for most investors; for proper diversification, you need to ante $500,000 and up — some would say even more than that. Further, SMAs can be expensive. They are not always being used properly either — for customization and tax-loss harvesting — rendering them, in effect, expensive mutual funds (for smaller accounts at least).
On the other hand, the SMA remains king of a managed accounts industry (there are several other permutations) that now holds more than $1.85 trillion in assets as of the second quarter of this year, a 20 percent increase from the same period in 2006. (By comparison, mutual funds have $11 trillion in assets.) But the SMA's dominance has waned over the last couple of years, as other fledgling segments of the industry, such as mutual fund advisory programs, have emerged as the new growth leaders. According to data from Cerulli Associates, as of the second quarter, SMAs accounted for $722 billion of the total $1.85 trillion managed accounts pie, an increase of 4.9 percent from the second quarter of 2006. But SMAs lost significant market share, accounting for 40 percent of the total market, down from 49 percent in early 2005.
Obvious reasons for the slower growth are that SMAs are mature, with a much larger asset base than newer managed account programs. Certainly, the dismal returns in equity markets have shrunken assets in SMAs, as well as everywhere else. Another possible reason for the slower growth mentioned by consultants is that the primary sellers of SMAs are wirehouses. While wirehouses have the wherewithal to use SMAs — with their gigantic sales forces catering to wealthier clients — some argue wirehouses have nearly reached a saturation point, that all those advisors and clients who can invest in SMAs have already done so. But the data clearly suggests it is also partly due to the growth of other options, including multi-manager variations, which feature several managers in one vehicle, as well as mutual fund advisory programs and the continued evolution of unified managed accounts (UMAs), which allow advisors to combine mutual funds, ETFs and SMAs inside one account with one manager overseeing it all.
One Florida-based Merrill Lynch advisor is representative of the trend. Sure, he has large portions of the portfolios of many of his largest clients ($5-million-plus in assets) in SMAs, but he rarely puts any new client assets into the products anymore. And these are precisely the clients the SMA was intended for. SMAs are too much of a hassle he says. “Having five accounts with five managers for one client is a lot to look after across a whole book,” he grouses. Instead, he estimates that more than 25 percent of client assets are now in the more operationally efficient multi-manager accounts, Merrill's Consults Diversified Portfolios, which essentially hold several SMA managers inside one vehicle. The number of managers and strategies is more limited, but the fee is also lower than for SMAs — and much easier to keep track of. For smaller clients — those with $250,000 to $500,000 in assets — he uses the firm's mutual-fund advisory program.
THE NEW BIG THING
Mutual fund advisory programs have seen the fastest growth of all managed account types, with $502 billion in assets as of the second quarter of this year, an increase of 46 percent from two years ago. These programs, which can be discretionary, are designed to provide clients with a systematic asset allocation to a broad range of mutual funds. Smaller accounts get diversification as well as account monitoring and portfolio rebalancing, for an industry average 1.17 percent asset-based fee, according to Cerulli Associates. What's causing the rapid growth? Baby boomer clients seeking to rollover 401(k) plans dominated by mutual funds see something they understand in these accounts — low investment minimums, a familiar investment vehicle and built-in advice. These rollovers have accounted for roughly 70 percent of new assets into mutual fund advisory programs, according to Cerulli. Firms such as Ameriprise (the leader with $64.9 billion in AUM), LPL and Fidelity have been raking in assets ahead of the wirehouse contingent (see table on page 47).
Of course, mutual fund advisory programs aren't without their demerits. In fact, the fees aren't always lower than a comparable SMA portfolio — despite first appearances. That 1.17 percent average fee, for instance, doesn't include the underlying mutual fund fees which add, on average, an additional 90 basis points — less if institutional shares are used — to the average total fee, says Cerulli. More than a few wirehouse advisors say even their wealthier clients choose mutual funds over SMAs because they think they pay less (fees aren't always as transparent). “The SMA fees are much clearer and some clients don't like that,” said one Merrill advisor. The transparency of fees in mutual fund advisory programs, as well as the use of fund share classes in these programs that carry 12b-1 fees, are both issues the SEC is studying. Generally, from a fee perspective, whether a client is better off in SMAs or some other investment or combination of investments generally depends on the size of the investable assets (see sidebar at left).
So, has the shine come off the SMA market? Not surprisingly, it depends on who you ask, but critics of SMAs typically target the advertised advantages. “A lot of an SMA sale is hype,” says Chip Roame, of Tiburon Strategic Advisors in California. “Clients like to hear that they own the individual securities, and that the SMA is customizable and tax managed. But tax efficiency requires tax management at year end and that doesn't always happen.” He adds, “And customization is relatively unimportant to most people who aren't senior executives with huge concentrated stock positions.”
In addition, in volatile times like these — where equity markets across the globe are faltering — an expensive SMA strategy that isn't delivering superior returns might be a hard sell for clients, especially when a basket of comparable ETF and mutual funds might get the same result or better — and less expensively. Bob Stone, managing director of Telemus Capital Partners, a dually registered wealth management firm with $3.3 billion in AUM and offices in Michigan and Texas, uses EnvestNet PNC's third-party platform to provide access to SMAs for his wealthy clients. But he says in at least one current situation, he's opted for other solutions: “We're not seeing a lot of alpha in large cap right now, so instead of using an SMA, we're resigned to using ETFs and getting beta, and looking for alpha elsewhere,” Stone says.
WELCOME THE UMA?
Jim Tracy, director of Investment Advisory Services at Citi Global Wealth Management, might suggest that one of his advisors with a similar situation consider one of the firm's new UMA platforms. Since the first platform, Select Portfolios, was launched in 2006, advisors have gained more choice and control in terms of picking managers and investments, says Tracy. A newer version, Select UMA, which was launched in April 2007, lets FAs pick money managers from an approved list and allows them to combine SMAs, ETFs, institutional share class mutual funds and a range of so-called “1940 Act funds” that invest in real estate, commodities and other alternative asset classes. Select UMA provides automatic rebalancing, allows for strategic or tactical asset allocation strategies and because one overlay manager handles trades, it can also provide tax efficiency. A newer platform expected to open in November provides an even greater menu of managers and allows for even more customization. “The SMA may not always be the right vehicle for a client, and there's a lot of flexibility in the UMA,” says Tracy. And for a $50,000 minimum — the same as most of the SMAs on Smith Barney's platform — an FA can better diversify a lower-level client's holdings.
Not all are convinced. The two titans of the RIA custodian world, Schwab and Fidelity, have focused heavily on expanding their SMA platform offerings to their RIA clients. Yet, both remain unconvinced that creating a UMA platform for their RIAs would be beneficial. That's not to say RIAs that custody with them can't use a third-party UMA provider. But both firms say the operational efficiency that could be possible from the UMA concept, while appealing, still isn't a reality. “We're in listening mode,” says Jeff Carlin, v.p. of national sales in Schwab Institutional's investment advisory products division. Just a few of the myriad issues Carlin says would need to be handled: For RIAs who want to make their own asset allocation and find their own managers, model-driven portfolios won't cut it. And what if an RIA wants to put concentrated stock in the UMA, how does that get priced? What if he wants to manage some of the money himself? “The assets in the UMA market are still small, so it's not like we've missed the next great thing,” says Carlin. “We just want to make sure the technology is there first so we can provide everything our RIAs want and need.”
According to FAs everywhere, one of the misgivings with current UMA platforms is actually the same reason it is loved: flexibility. Critics say the beauty of the idea of the UMA — one account for all of the client's assets with one set of reports — is impossible to achieve. At present, anyway. For one thing, per ERISA, retirement assets can't mingle with non-retirement assets. And insurance products and alternatives, such as hedge funds and managed futures, also can't be carried in current UMA structures. And those concentrated stock positions? Nope. Even if those limitations aren't a problem, there is the fact that some prominent SMA managers still don't want to be on UMA platforms. Why? One reason is that they must share their trading model with the overlay manager — posing an intellectual property theft concern for some; they also must share some of their fee. “I don't know a single FA using it. We get a lot of emails about it, but as far as early adoption goes, I've learned that, if anything, being first into something isn't always advantageous,” says one Merrill FA. “And until we can fit everything in there, there's no compelling reason to use it,” he says.
Citigroup's Tracy acknowledges that some SMA managers don't want to participate in UMA platforms, but says it has more to do with the extra wholesaling coverage and additional education support required. But he thinks that will change. “There's not a lack of interest on the part of managers. They view the UMA as another way to distribute their intellectual capital,” he says. And make money, says Tiburon's Roame: “I think it's a short-term issue. Why? The same reason every fund company is now on Schwab's OneSource platform — the assets. If there is a trillion dollars in assets, they will participate.”
STILL MOST ADVANTAGEOUS
For Bob Stone, whose RIA firm manages $3.3 billion in AUM with average clients in the $2 million to $3 million range, the UMA is something he's been hearing about for years, he says, but with little follow through. As for the SMA, the muddle-through market may have dampened his interest in large cap SMA strategies, but the value of the SMA — despite its inherent administrative headaches — hasn't deteriorated one bit, and for one simple reason: “The bottom line is that if you want the top managers, the only way to get access to them is through an SMA.”
According to Tracy, despite what one set of data may indicate, Smith Barney advisors still see SMAs as a crucial asset management tool and client money continues to flow in. “SMAs still garner the biggest asset flows, more than mutual fund advisory and our other managed programs,” he says. At RIA custodians Schwab and Fidelity Investments — the wires biggest competitors for assets — SMAs are also raking in assets as these firms continually add to the platform offerings. Assets at both Schwab ($36 billion in SMA assets) and Fidelity ($13 billion in SMA assets) reside primarily on the firm's traditional platforms, which offer hundreds of managers and thousands of strategies. But newer SMA-wrap type platforms as well as fully and partially outsourced platforms with lower costs, less comprehensive manager menus and varying degrees of advisor control have been attracting assets, too. Fidelity launched two such variable platforms in partnership with EnvestNet PNC last year and says advisor response has been very positive, although it's too early to calculate growth rates.
SMA FEES: WORTH IT?
You'd better be doing more than just picking funds.
SMA fees aren't so expensive when compared to mutual funds — at least for wealthier clients. At Merrill Lynch, where SMAs are widely used, a client with $500,000 in assets to invest would pay 2.75 percent for a portfolio of five equity SMAs, says one FA. This quote includes the manager's fees, Merrill's cut and his own advisory fees without a discount. Not cheap. On the other hand, a balanced portfolio of five SMAs at $100,000 a piece — say three equity managers and two fixed income — would ring in a fee of 2.15 percent, he says. “But that's before any discounting.” By comparison, a portfolio of five mutual funds in Merrill's mutual fund advisory program would cost 1.25 percent (asset-based fee), plus approximately another 0.50 percent to 0.75 percent for the institutional share class fund expenses — for a total of roughly 2 percent to 2.25 percent. “Above $500,000 the SMAs are better, at that mark it's about even, and below that, SMAs aren't as cost-effective,” says the FA.
TOP 10 MANAGED ACCOUNT PROGRAM SPONSORS BY AUM
|Total Managed Account Assets ($bil)
|Source: Cerulli Associates
TOP 10 SEPARATE ACCOUNT SPONSORS BY AUM
|Bank of America
|SunGard Advisor Technologies
|Source: Cerulli Associates
TOP 10 MUTUAL FUND ADVISORY PROGRAMS BY AUM
|Source: Cerulli Associates