March 24, 2005

The Best Separate Account Managers

From S&P, Prima Capital, and Investment Advisor: The winners of the first SMA Awards

Separately managed accounts are gaining traction with advisors crafting portfolios for clients. By the end of 2004, managed accounts (many people use "separate" and "managed" interchangeably) contained $576 billion, up 50% from only two years ago. As managed accounts have grown in importance, so has the need for information about them. That is why Investment Advisor has teamed up with two highly respected names in investment research and analysis--Standard & Poor's and Prima Capital--on this, the first U.S. Separately Managed Account Awards. Together, we have identified the best managers of the best separate account products on the street.

Managed accounts have a storied history: They were born at the old E.F. Hutton in the 1980s and remain a wirehouse fixture to this day. Indeed, the Money Management Institute, a trade group, estimates that six major brokerage firms--Hutton's successor, Smith Barney, along with Merrill Lynch, Morgan Stanley, UBS, Wachovia, and A.G. Edwards--still hold some 70% of managed account assets. Other channels are getting in on the act now, however. MMI Executive Director Christopher Davis observes that managed account assets are growing rapidly at banks, and Chip Roame, managing principal at Tiburon Strategic Advisors in California, notes that 7% of fee-only advisors deploy managed accounts in their practices. These advisors, adds Davis, are notable for having accounts that are larger than industry averages.

Advisors use managed accounts, sometimes as a substitute for mutual funds, for a number of reasons. They may fill gaps in a portfolio that a mutual or exchange traded fund can't easily occupy, or offer bespoke tailoring--a manager could, say, accommodate an advisor who desires exposure to mid-cap equities but wants to underweight financial issues, a mainstay of mid-cap indexes, at a time of rising interest rates. Tax efficiency is another plus. While many mutual funds boast low turnover and modest capital gains distributions, a managed account may offer the same benefits plus the ability to selectively harvest losses to offset gains a client may have earned elsewhere. There's also the cachet factor: Not available to the general public, separate accounts are generally offered with minimum investments of $100,000 to $250,000 and up. Many separate account managers, especially those at smaller firms, are also available to advisors and clients for questions on their strategies and goals. Just try getting hold of a mutual fund manager.

Picky, Picky

For all the benefits of managed accounts, however, selecting the right products from the hundreds on the market remains a hassle for the busy advisor when compared with the ease of picking mutual funds. That's a pity. Phil Edwards, managing director of Standard & Poor's Investment Services, points out that "there are an awful lot of good separate account managers who don't offer mutual funds," especially in the small- and mid-cap categories.

To be sure, wirehouse and regional brokers have legions of analysts performing due diligence on asset managers. For independent advisors, though, especially those who don't use turnkey asset management programs available through various broker/dealers, poring over databases to make the best manager selection can be a tiresome task.

That is where the SMA Awards come in. Focusing on products that are available to retail investors, as opposed to those aimed primarily at corporate retirement plans and other large institutions, we combed through the deep database of SMA Evaluator (www.sma-awards.standardandpoors.com), a research service provided by Prima and S&P. Our Awards Committee--Prima President Gib Watson, along with Senior Analyst Nathan Behan and Geoffrey Selzer, Prima's director of professional services; S&P's Edwards; and IA Editorial Director William Glasgall--then selected seven asset managers as our first U.S. SMA Award winners.

The winners are a diverse lot, including large and mid-sized firms as well as a number of boutiques. They include Eagle Global Advisors, ICM Asset Management, New Amsterdam Partners, Nuveen Asset Management, Thornburg Investment Management, Smithbridge Asset Management, and WCM Investment Management. The honors cover the winner's management of specific equity and fixed-income products as well as a special award for tax efficiency. You'll find profiles of the winners beginning on page 78.

Two things the SMA Award winners have in common are consistent risk-adjusted investment performance as well as a willingness to put their firms' resources both into running separate accounts and delivering superior service to their clients. A third attribute the seven award winners share is plenty of experience. A product has to be on the market for at least three years to have its manager qualify for consideration for the SMA Awards. That was no problem for our winners: The products they manage have been around at least since 1997, giving them time to show their mettle through some of the most volatile markets in recent history. One of the award-winning separate account products, New Amsterdam's Mid-Cap portfolio, made its debut several months before the 1987 stock market collapse, and Thornburg's Bill Fries has been assembling his brand of value portfolios for more than three decades, picking up plaudits from Morningstar and Business Week magazine for the mutual funds he manages.

Experience counts in another way as well. Unlike many manager evaluation systems that simply look at risk-adjusted performance over set periods, say, three or five years, we looked at a managed account product's history since the day it came to market. This is only one of the criteria we used in picking the SMA Award winners. Let's take a moment to review how we made our selections, all of which are based on Prima's data through December 31, 2004.

How We Made Our Picks

We started with the approximately 620 separate account products currently listed in the SMA Evaluator database. We also invited managers that are not listed in the database to submit reports on their products. To ensure that our judging process was focused on separate accounts aimed at the retail investor, we excluded products that are closed to new investors or have account minimums above $250,000. We also screened out managed accounts run by individual stockbrokers for small groups of clients as well as proprietary products with limited or no distribution outside the parent's firm. While there are some 5,000 managed account products currently on the U.S. market, those making it through our first screen more accurately reflect the 800 or so marketed widely to individuals. "We took off the bottom feeders and the huge institutional managers who run $25 billion portfolios," notes Prima's Watson.

Having defined our territory, we then moved on to evaluating firms offering separate accounts. While it didn't exclude smaller companies, Prima's firm score favored those with at least $1 billion under management--one clue to their long-term viability as well as their ability to attract top-flight investment pros. Prima also gives points to firms where investment research and portfolio management team members are owners, as well as to businesses whose CEO or CIO have been in place for more than five years.

Next came the resources score. Among other things. Denver-based Prima looked at the number of analysts and portfolio managers a firm has, both in relation to its total staffing as well as to the number of securities in its portfolio. This gave us an idea of the investment pros' workloads as well as how much emphasis their firms put on investment staff.

The Performance Effect

Portfolio managers' tenure is important as well, as is their products' importance to their firms in relation to their total assets under management. In addition, Prima evaluated whether the "performance effect" is a hindrance or a benefit. A small-cap portfolio, say, can certainly achieve some economies of scale as it grows from $750 million to $2 billion. But at that size, the product may not be as nimble or effective as it was when it was smaller.

Client service is so important in the managed account world that it merits a score of its own. Prima looked at how responsive a firm is to requests for customization, where appropriate, along with how often it stays in touch with advisors and their clients. Another area that has its own score, as well as its own winner in Smithbridge, is tax efficiency. To generate the tax efficiency score, Prima looked at "tax friction," the percentage of a product's gains that are lost to capital gains levies, as well as tax management techniques and the ability clients have to improve their tax situation through loss harvesting. With recent changes in the tax laws favoring corporate dividends, Prima gave extra credit to managers with higher-yielding portfolios.

The final criterion is performance. Prima and S&P relied on a proprietary model that ranked performance against appropriate benchmarks and the results of peers. But the model also considered consistency to smooth out single periods of extreme outperformance that can skew a manager's long-term average returns. Says Watson: "This separates the skilled from the lucky."

To come up with a final performance score, each managed account product received six individual scores calculated over rolling three-year periods. Three of the scores were based on the product's average alpha, its excess Sharpe ratio, and excess return against its benchmark and peers. Three scores were based on the overall consistency of these measures. While no system can see into the future, this one can give advisors clues about the range of relative performance they may come to expect.

Once the numbers rolled in, the human factor came into play. The Awards Committee debated a substantial list of finalists. We decided early on that a given asset class could have more than one victor; such was the case for the large-cap and small- to mid-cap categories. We combined the small- and mid-cap categories, incidentally, because of the limited number of players in these areas and owing to the propensity of some managers, including ICM, to use both asset classes in a single portfolio. We also combined the short- and intermediate-term bond categories in that Nuveen was a clear winner in both.

We excluded products whose managers had all but stopped taking new assets, however, even though they had not officially closed their doors to additional clients. We also screened out products with very limited distribution or where the judges were concerned about a lack of a formal succession plan for veteran asset managers. In addition, we excluded products that earned high scores in some categories but poor ones in others.

In the following pages, you'll see profiles of the seven U.S. Separately Managed Account Award winners, including tables about their products, courtesy of Prima Capital. On their own or taken as a complete portfolio, the winners deserve your attention.

Editorial Director William Glasgall can be reached at bglasgall@investmentadvisor.com. Freelance financial writer Savita Iyer can be reached at siyerwriter@yahoo.com.

CATEGORY: LARGE-CAP

THORNBURG INVESTMENT MANAGEMENT

If you ask Bill Fries how he defines value, get ready for a long explanation. However the veteran asset manager describes it, Fries's concept of value, as well as his firm's attention to separate accounts, both stand out. "There is a real need for people to focus on all the elements of what it takes to deliver a product," he says.

Fries's Value Equity separate account is similar to the Thornburg Value mutual fund, which is also managed by Fries and has won plaudits from Business Week and Morningstar. But the average retail investor's separate account size is larger, at $275,000, and the Value Equity portfolio is also slightly more concentrated and open to customization. Fries doesn't usually handle client relations himself, leaving that to a group of 15 execs. But he is well aware of clients' needs. "We try to be accommodating," he says. "I want to provide them the opportunity to feel comfortable."

Fries and his 11-member investment team in Santa Fe, New Mexico, think that three types of stocks make value investments. About 36% of the portfolio is composed of classic value issues, largely cyclicals with low price/book and price/earnings ratios. Undervalued companies with consistent earnings, including pharmaceuticals, make up another slug. Last come what Fries calls "emerging franchises," that could, over a five- or six-year period, turn out to be cheap. Among his emerging picks: E*Trade Financial and XM Satellite Radio, Fries's companion during his morning commute.--William Glasgall

WCM INVESTMENT MANAGEMENT

Paul Black, president of Orange County, California-based WCM Investment Management, and WCM's Focused Growth portfolio team, works hard to tune out the noise and cut through the clutter that bombards investors from every angle. "We focus on what is knowable, and stock prices are not knowable," Black says. "It sounds old-fashioned, but first and foremost we look to own great companies based simply on the long-term merits of their businesses. Short-term price movements or the latest round of headlines are totally irrelevant, although 99% of the investment world is pathologically mesmerized by them."

Understanding a company's long-term prospects depends first on whether it has an "economic moat" to protect it from competitive threats, Black says. But WCM also places a premium on corporate culture. This, Black says, sets the firm apart from peers. "Wall Street tends to like companies that cater to shareholders, but we believe that shareholders will be ultimately rewarded if there is a superior culture within a company, if there is a deep, strong set of leaders who are very focused on the ultimate values and goals of the business, and who are effectively communicating that vision throughout their organization," he says.

Few companies make Black's cut: WCM's Focused Growth portfolio invests in only 20. Black says owning more stocks would be pointless and would only "dilute their holdings with other, not-so-good ideas." Since Black and colleagues Jim Owen, Kurt Winrich, and David Brewer bought out the original WCM Investment Management in the mid-1990s, business has grown tenfold, to $2.5 billion under management.--Savita Iyer

CATEGORY: SMALL-/MID-CAP U.S. EQUITY

ICM ASSET MANAGEMENT

Kevin Jones, senior portfolio manager for Spokane, Washington-based ICM's mid-value equity products, looks for companies others have shunned, on the belief that they will eventually turn around and make great buys for others. "We buy a company when we think it will go from having a 5% ROE to a 15% ROE, and value it in the manner in which it is supposed to be operating," Jones says.

Case in point: PerkinElmer, a maker of life sciences, optoelectronics, and analytical instruments, whose stock price in 2002 was a mere $6 when Jones bought in. Today, PerkinElmer is at $22, the majority of Wall Street analysts covering it rates it a buy, and, Jones says, it makes for a great sale. There are many similar companies, yet Jones, who works closely with Jim Simmons, founder of ICM and manager of its small-cap product, believes that only a few carefully picked names are necessary for successful results. So out of a universe of 2,500 companies, only 40 to 60 go into ICM's portfolio. Turnover is low, as companies are purchased with a two- to three-year investment horizon.

Simmons and Jones share a close relationship with each other, their two other portfolio managers and seven research analysts, and other employees. "In the separate account business, you can reach out and touch your clients, and that sense of responsibility and personal touch goes through our entire company," Jones says.

ICM has $2.3 billion in assets, of which $1.2 billion is in small-cap and $700 million in mid-cap products. Forty percent of the investor base for the mid-cap product is retail.--Savita Iyer

NEW AMSTERDAM PARTNERS

A strong emphasis on both quantitative and qualitative research is necessary for any investment program to succeed, says Michelle Clayman, founder, managing partner, and chief investment officer of New York-based New Amsterdam Partners. New Amsterdam, which manages $4.5 billion in assets primarily for large institutions and entered the separate managed account business in 1999, uses a quantitative model to rank securities in the large-cap, mid-cap, core, and growth areas. Next comes rigorous fundamental analysis, where growth strategies and prospects get assessed. "We then build a 40- to 50-stock portfolio spread across a range of industries," Clayman says.

New Amsterdam seeks out reasonably priced companies with a strong growth potential, although Clayman concedes that her nine-member investment staff has proven itself better at stock selection than sector rotation. It has also developed a collegial approach. "Over the past few years, we have built a strong working culture here," Clayman says. "This is a friendly firm and we like to interact in an informal manner with one another."--Savita Iyer

CATEGORY: INTERNATIONAL EQUITY

EAGLE GLOBAL ADVISORS

At Houston-based Eagle Global Advisors, no one is a specialist, yet all partners bring different perspectives to the table. Founders Steven Russo, John Gualy, Eddie Allen, and Thomas Hunt say theirs is a firm of generalists. While international equity investing requires each to monitor one area of the globe and several industry sectors, they still maintain that objectivity and a disciplined investment process is what has insured their success thus far. "If someone is interested in any stock in any part of the world, he can present it to the investment committee," Hunt says. "We think that this is very important because it means that we are not pressured to invest in any particular part of the world, in any particular industry sector or individual stock."

Eagle's $400 million International Equity portfolio is invested in high-quality, large-cap companies in Europe, Asia, and emerging markets, and is also well diversified across multiple industry sectors. The firm has $891 million under management, primarily for high-net-worth individuals. It buys American depositary receipts for accounts below $3 million, and ordinary shares for larger clients.

Russo, Gualy, Allen, and Hunt launched Eagle in 1996 and still own 100% of the company. Over the years, they have developed a competitive, yet friendly relationship. "We can sit down and speak honestly to each other with the goal of making the best investment decisions for our clients," Russo says.--Savita Iyer

CATEGORY: FIXED INCOME

NUVEEN ASSET MANAGEMENT

Anthropology. Religion. The Classics. They're as far removed from municipal finance as anyone could imagine, but these are the subjects in which staff members of Nuveen Asset Management hold doctorates.

Marty Doyle and Fernando Christiani, the Philadelphia-based head portfolio manager and product manager, respectively, for Nuveen Asset Management's short and intermediate municipal bond funds, like to employ Ph.D.s with a range of educational backgrounds. Although pure finance professionals, both by education and work experience (Doyle is a CFA and both have MBAs), they believe that anyone who has done the kind of in-depth research required for a doctorate truly understands the process necessary to crack the often arcane municipal bond market. "When you've done a Ph.D., you know how to learn, how to gather information," Christiani says. "We need people who can get the necessary information from issuers."

Idea-sharing is critical to Nuveen's relationship with advisors. The firm has a dedicated wealth management team that works with individual advisors on issues clients might come across while trying to achieve financial goals, particularly the tax consequences of investments. Nuveen provides customized portfolios both at a state and national level. The firm has $57 billion under management, of which $10.5 billion is in separate accounts.--Savita Iyer

CATEGORY: TAX EFFICIENCY

SMITHBRIDGE ASSET MANAGEMENT

Separate account managers like to claim their strategies are tax-efficient, but not all measure up. One that certainly does is Smithbridge Asset Management, an eight-year-old boutique based in Chadds Ford, Pennsylvania that captured this year's SMA Award for tax efficiency. The Smithbridge Growth Equity portfolio is noteworthy for benchmark-beating performance, modest turnover, and intense attention to tax management of clients' portfolios that begins shortly after Labor Day with a review of possible losses to be harvested.

Growth Equity is a concentrated large-cap portfolio of "companies that grind out earnings in a consistent manner for the long term," says Jonathan Kolle, a Smithbridge vice president who picks stocks alongside founder Joe Champness, who launched the firm in 1997. Kolle says that discipline prevented them, in the stock market's bubble years, from buying IPOs of hot technology and telecommunications companies "that had no sales and no earnings."

Although Smithbridge's portfolio is spread across the S&P 500, it typically contains only 25 to 30 stocks and is currently underweighted in technology and overweighted in healthcare issues, including Medtronic, Stryker, and Johnson & Johnson. "Once you get past 22 or 23 issues, the diversification benefits diminish," Kolle maintains.

About two-thirds of Smithbridge's clients are wealthy individuals, and to minimize their tax liabilities Kolle and Champness keep portfolio turnover down to a "comfortably low" 20% to 30%. They also like to meet with clients, many of whom are referred to them by RIAs, at least once a year.--William Glasgall

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