From the May 2006 issue of Boomer Market Advisor • Subscribe!

The separately managed advantage

The recent bear market, which caused mutual fund investors to suffer from the double jeopardy of taxable capital-gains distributions and paltry returns, whetted baby boomers' appetite for separately managed accounts. After years of moderate growth (assets in separately managed accounts grew from $75 billion in 1994 to $275 billion in 2001, according to Cerulli Associates), it appears that SMAs are finally gaining the foothold industry watchers have long anticipated.

According to the Money Management Institute, assets under management in SMAs grew by 17.7 percent in 2005, to $678.1 billion, compared with the $576.1 billion reported in December 2004. This continued growth puts the industry in line to reach $1.5 trillion by 2011, according to a McKinsey and Co. report commissioned by the Institute.

Major brokerage firms like Citigroup and Merrill Lynch have deployed SMAs in their networks for some time and Russell, Parametric and Janus have all recently announced expansions to their offerings. Schwab also introduced a new service through which investors can directly access the separately managed accounts listed on its platform.

Under the Schwab plan, investors can choose from two SMA programs: Managed Account Select and Managed Account Affiliates. Managed Account Select lets investors choose from approximately 40 third-party money managers and provides access to research from the consulting firm Callan Associates.

"SMA assets continue to grow because an increasing number of investors, particularly those contemplating retirement over the next 15 years, are seeking professional investment advice," says Mark Pennington, a partner at investment manager Lord Abbett.

"When an advisor seeks to create a customized investment solution, a managed account is often a key element of the plan."

"The biggest surprise we've seen in the past few years is the number of high-net-worth clients admitting that they need help," says Michelle Knight, co-head of fixed income portfolios for Atlantic Trust Private Wealth Management in Atlanta. "They want a single cohesive strategy that is managed in such a way that it simplifies their lives while providing sufficient amounts of growth and income to maintain their lifestyle."

Separately managed accounts allow wealth managers to build and maintain portfolios based on their client's risk tolerance, age, financial goals, charitable inclinations, social consciousness and tax efficiency. Their primary appeal is the manager's ability to customize the asset allocation and portfolio diversification to the unique needs of each client.

Private wealth management firms produce in-depth, customized profiles that detail each client's investment approach. Initial asset allocation strategies are then structured to meet pre-determined goals. The criteria for reallocating assets based on the client's personal and business needs, as well as changing market conditions, are also defined.

SMAs invest in a comprehensive range of asset classes, including international and nontraditional classes, as well as traditional equity and fixed income categories. A customized benchmark to measure performance is developed between the client, the advisor and the manager to ensure alignment with long-term investment goals.

To establish a managed account program, investors first complete a comprehensive questionnaire. Based on the answers, money managers are chosen. Portfolios are then designed, implemented, and managed. Funds are never commingled, or pooled with other investors, and separate commissions for security transactions are not charged.

Underlying investment transactions can also be timed to limit any adverse tax consequences. The manager of a separately managed account has the freedom to pursue and implement low-investment-turnover strategies (a measure of how frequently assets are bought and sold) in order to minimize current income tax consequences. Unlike SMAs, mutual funds typically pass along built-in taxable capital gains to their investors. Because an SMA's portfolio is constructed from the ground up, specifically for the individual investor, it does not inherit other investors' tax consequences.

Separate account managers often will work with a client's tax advisor to employ loss-harvesting techniques (offsetting gains with losses) when appropriate. A strategy known as "doubling up," which involves recognizing a loss on a particular stock for tax purposes while still holding a position in that stock, is also often employed.

Boomer clients are beginning to recognize these benefits. When compared with other alternatives, managed accounts can offer significant added value. They include a written investment policy statement, professional portfolio management and performance measurement reports. These are services that would be cost-prohibitive if each was implemented separately.

Managed accounts are flexible and transparent, with no hidden charges. Fees are clearly disclosed, typically paid on a quarterly basis and often tax deductible. These fees range from 1.15 percent to 2 percent of assets and generally cover investment planning, asset allocation, goal planning, risk tolerance, portfolio management, performance measurement and trading commissions.

"Providing support for the managed account marketplace is a key growth area for us," says Steven A. Smith, head of business development for JPMorgan Managed Account Solutions.

Baby boomers are the first generation to retire without the safety net of corporate pensions. They will therefore demand products and services that help them achieve a comfortable retirement and peace of mind. Of all the benefits separately managed accounts have to offer, none is more important for clients than knowing experienced advisors and managers are working for them to ensure their long-term goals are achieved.

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