Since their introduction in the early 1970s, separately managed accounts have changed very little. The tools for selecting separate account managers and the technology for offering the accounts to investors have evolved significantly, but the basic product has remained much the same. Now, that is changing--in a way that could reshape the separate account industry.
Change has come in the form of the "Multiple Discipline Account" or MDA. Citigroup, which debuted it more than 5 years ago, owns the term "Multiple Discipline Account" so the Boston-based consulting firm of Cerulli Associates suggests others call it a multiple style account, or MSA. Meanwhile, Checkfree, the largest provider of back-office systems to the managed account industry, is using the term "multiple strategy portfolio" or MSP. To avoid taking sides in the name game, we'll refer to them simply as multiple manager accounts (MMAs). But whatever you call it, this new breed of separately managed account is suddenly attracting a horde of new players, including wirehouse and regional brokers and firms serving independent financial advisors.
An MMA is a single, separately managed account that incorporates multiple investment styles, each managed by a different investment manager. The managers can be affiliated with a single investment organization, or they can be unaffiliated managers invited to participate in the MMA by the product sponsor. The portion of the account allocated to each style, and the managers included in the account, are predetermined by the firm sponsoring the MMA. So, in effect, MMAs are prepackaged, multistyle, multi-manager portfolios maintained within a single brokerage account.
The best way to underscore the significance of the MMA is to contrast it with the traditional way separate accounts are used to construct portfolios for investors. Today an advisor using separate accounts to build a portfolio must go through the effort of developing a proper asset allocation strategy for the client and then selecting managers to implement the strategy from a list that might easily include 40 to 60 managers and up to 100 products. The advisor might receive some help from the firm sponsoring the separate account program, but, under the best of circumstances, the process can be time-consuming and is often overwhelming for those unfamiliar with the world of separate accounts. Once managers are selected, the client opens up a separate brokerage account for each manager selected and funds that account with at least the amount necessary to satisfy the manager's minimum account requirement. This is typically in the range of $100,000 to $250,000 per manager.
Lowering the Bar
From the client's perspective, MMAs have some distinct advantages over the traditional approach. First, to achieve proper portfolio diversification using separate accounts, a client must have significant assets in order to meet the minimum account requirements of each manager. Experts differ, but most would say that an investor should have between $500,000 and $1 million to build a well-diversified portfolio using separate accounts. MMAs allow a client to achieve a reasonable level of diversification for significantly less: The minimum required to open an MDA account at Citigroup is a comparatively modest $100,000; it runs up to $150,000 at some other firms.
This means a client with a smaller account can also benefit from reduced volatility and more consistent performance, which should help the client stick with his or her investment program over the long term. Clients also benefit because an MMA is managed using a single brokerage account rather than a series of separate accounts for each manager. This means less effort to open an account, far less paperwork going forward, and cleaner performance reporting. The result is less confusion and fewer administrative headaches for the investor.
From the advisor's perspective there are advantages, too. Advisors new to separate accounts are spared asset allocation and manager selection decisions that they may be uncomfortable making. In addition, an increasing number of advisors are looking for ways to focus more attention on developing and maintaining client relationships and less on technical investment issues. For such advisors, MMAs present an opportunity to delegate asset allocation and manager selection decisions to experts. But even experienced advisors who are not ready to relinquish control over such important matters as asset allocation and manager selection in all cases may find MMAs ideal for clients with accounts in the $100,000 to $500,000 range. That is because MMAs still offer the tax and customization benefits of separate accounts, but in a more streamlined and efficient package. So advisors can still offer separate accounts to clients whose account size does not justify the significant effort that can be involved in developing a portfolio of separate accounts tailored specifically to the client's needs.
MMAs have one more advantage that may prove important as this product evolves. Because of the way MMAs are managed, trades from each manager who runs a portion of the account are sent through a central "overlay portfolio manager." The overlay manager can review the trades and coordinate overall portfolio activity. This can ensure that one manager is not selling a security that another is buying. The overlay manager can also control duplication in the holdings of the managers in the account. This centralization of trading activity presents the possibility for a higher level of tax management than has existed in the industry to date.
Will Managers Adapt?
There are some negatives associated with the MMA concept. Some advisors, particularly those who are schooled in selling "process" rather than "product," may look down their noses at MMAs as a prepackaged, cookie-cutter solution. It's also not entirely clear yet how managers will modify their investment processes to fit within the MMA environment. A manager that is used to managing $500,000 separate accounts today may have to adjust his approach when he begins receiving $30,000 for its portion of an MMA. Also, because trading activity is centralized in an overlay portfolio manager, managers are now one step removed from the trading process. The impact of this is not fully known. There are other operational and back-office issues as well that still remain to be worked out. And at this time only the Citigroup organization has significant experience in sorting through them. These issues are likely to be addressed as the industry gains experience and develops new technologies to handle the challenges.
So how do you find out more about MMAs for your clients? After all, MMAs are still a bit of a scarce commodity. Although Citigroup pioneered the MMA concept, it has only recently captured the attention of the rest of the industry. Perhaps that is due to recent reports of the success the product has generated within the Citigroup organization. Cerulli Associates recently reported that Citigroup has garnered more than $10 billion in assets in its MDA product using its proprietary investment management capabilities. Citigroup's sister organization, Salomon Smith Barney Consulting Group, also has a version of the product, called a diversified strategic portfolio, or DSP. It uses outside money managers, including J.P. Morgan Fleming Asset Management, Alliance Capital Management, Putnam Investments, Strong Capital Management, and TCW Investment Management.
But Citigroup's product development activities have not gone unnoticed. Now the rest of the world is playing catch-up. Since the beginning of the year, a number of new programs have been launched. Brinson Advisors, for example, opened up a program called Private Wealth Solutions that is managed by UBS Asset Management, Brinson's parent, and is available through UBS PaineWebber. First Union Securities teamed up with Affiliated Managers Group to offer Diversified Managed Allocation Portfolios using managers affiliated with AMG. ADVISORport recently launched its Multi-Strategy Account or MSA, the only true MMA-type product currently available to independent financial advisors. The ADVISORport product is also unique because it is the first to incorporate totally unaffiliated managers in a single account, and it utilizes a tax management overlay developed by Tamarac Inc. to improve the tax efficiency of each account. Yet ADVISORport's MSA is priced at levels comparable with conventional separate accounts--about 115 basis points. Advisors typically tack on another 100 basis points, although the total cost typically falls as the account size increases.
Here Come the Big Names
In addition to ADVISORport, money management organizations, including Allianz, Eaton Vance, Franklin Templeton, and Old Mutual are all developing MMA products incorporating the investment management expertise of firms that fall under their respective corporate umbrellas. On the brokerage side, Merrill Lynch and A.G. Edwards are also reported to be developing MMA products. Checkfree has developed the back-office systems to support clients who want to develop these products, so it is safe to assume that MMA projects are in the works on a widespread basis at financial services firms throughout the country.
Why the great interest in MMAs? The reason is simple. The product holds the potential to open the floodgates and allow new assets to pour into separately managed accounts. Despite a lot of publicity, separate account use is still not widespread among advisors. In wirehouses, which dominate the separate account market with a 75% share, somewhere between 2% and 5% of brokers account for 80% to 85% of all separate account business. In the independent advisor world, the story is not much different. A little over a year ago, Schwab Institutional estimated that fewer than 10% of the advisors it works with have separate account business on their books. This has a lot to do with the complexity of using separate accounts, the high account sizes necessary to build diversified portfolios with separate accounts, and the fact that advisors wishing to use separate accounts must learn how to select managers and combine them effectively in portfolios. These obstacles have kept many advisors from making the move to separate accounts.
MMAs go a long way toward removing those obstacles and opening the world of separate accounts up to huge numbers of advisors that never used them before. Steve DeAngelis, president of ADVISORport, believes that MMAs fill a gap in the product line up between mutual funds and separate accounts. By filling this gap DeAngelis believes that use of separate accounts by advisors could reach 50% within a few years. And Bob Del Col, CEO of FundQuest, believes the potential to increase penetration among advisors could be even greater. His firm is so committed to the concept that it has decided to build an MMA supermarket as a result of the interest expressed by several of FundQuest's insurance and bank broker/dealer clients. The broker/dealers want access to MMAs managed by well-respected mutual fund companies that their reps and clients have been working with for years. Del Col is targeting a mid-year launch for the supermarket. Based on early commitments, he expects it will feature up to 30 mutual fund companies with more than 60 products. The supermarket will complement the managed account and variable annuity programs FundQuest already offers.
FundQuest's menu reflects the widening diversity of investment options in MMAs. Citigroup, for example, offers seven equity portfolios with two to five styles each, plus seven balanced portfolios with three to five styles apiece. ADVISORport, meanwhile, offers eight portfolios: two U.S. equity, two global equity, two U.S. balanced, and two global balanced.
Certainly MMAs have the potential to make separate accounts vastly more accessible to new legions of advisors and clients alike. But their significance goes far beyond that. MMAs open the door for large money management firms that have not been major players in the separate account business to gain a foothold. As the separate account industry has evolved, many of the money management firms that have gained the largest share of the action are institutional managers with a boutique focus on one or perhaps a few styles or asset classes. These firms are not particularly well suited to developing and distributing multi-asset class MMA products on their own.
To succeed in the MMA environment they must take the difficult step of partnering up with competitors or joining forces with affiliated firms that may be part of a larger corporate organization. Firms like large mutual fund complexes, on the other hand, are perfectly suited to developing such products. And, now that growth in the mutual fund world has trailed off, they are unlikely to let the opportunity to become significant players in the separate account world pass them by again as they did when the mutual fund industry was experiencing meteoric growth.
The entry of these larger, better known money management organizations into the separate account world will further accelerate the growth of the industry. The large mutual fund firms are well known to the vast majority of advisors and their brand names carry weight with clients. Advisors are already comfortable with their products and have relationships with their wholesalers. These firms have large distribution networks and significant marketing budgets. They are well positioned to leverage their existing relationships to help advisors make the transition to separate accounts. All they need is the product that can serve as a vehicle for the transition. MMAs supply the answer. In fact, the technology is now available to allow these large organizations to go directly to advisors with an MMA product, bypassing the sponsoring firms entirely.
Looking down the road, MMAs are a sign of perhaps even more fundamental changes still to come. Today's MMA product has its own set of limitations. The asset allocations and the managers in the product are predetermined and inflexible, except in the case of the largest accounts. However, as the technology that supports MMAs evolves, it is easy to imagine a new and improved MMA that gives advisors the option to customize the asset allocation strategy and select which managers will be used to implement that strategy--all within a single brokerage account. Use a little more imagination and you can envision a single account that incorporates multiple separate account managers as well as mutual funds, ETFs, hedge funds, and individual securities. Stretch a little farther and you can see how the type of trading capabilities developed by FOLIOfn might be applied to large numbers of such accounts to bring trading costs down to nothing.
That, of course, is a level of flexibility, customization, tax sensitivity, and efficiency that simply does not exist today. But with innovative firms like ADVISORport, Citigroup, and FundQuest using new ideas and new technologies to gain a competitive edge, and with mutual fund complexes and other large money management firms entering the equation, the holy grail of a truly product-neutral, cost-efficient investment consulting platform can be a reality in the near future.