Advisors can’t be drawn with a broad brush. Some like to be their own portfolio manager. Others believe they possess special insight into a given asset class or sector or vehicle. Still others—perhaps most—heed Clint Eastwood’s famous dictum that “A man has to know his own limitations” and choose to focus on advisory duties other than managing money. They thus set an asset allocation for their clients based on risk tolerance and goals, and choose professional money managers to whom they hand off investment picking.
This is the ninth year that Investment Advisor is partnering with Prima Capital to assist advisors in their investment outsourcing duties by recognizing the Top Separately Managed Account Managers of the Year in multiple categories. For the first time in the SMA Managers of the Year franchise, one individual manager will be recognized as the best of the best during Envestnet’s Advisor Summit in Chicago on May 2 and in the pages of Investment Advisor.
Prima may have had a slight name change—following Envestnet’s 2012 acquisition it is now called Envestnet | Prima—but it hasn’t changed its raison d’etre: to conduct due diligence on money managers that goes far beyond gathering and publishing performance figures.
“We’ve been at this for a while,” explains Gib Watson, who founded Prima Capital in 1999 and is now vice chairman of Envestnet. Throughout that time, “our focus has been on bringing institutional grade research and the due diligence process into the high-net-worth market.” Watson (left), who has sat on every SMA Managers of the Year awards committee, says Prima focuses not only on quantitative and performance analysis but also holdings-based analysis.
“We’re seeking to understand the quality of the firm,” including the people there, and determine whether there is “clarity in the manager’s alpha thesis” that is repeatable and sustainable, Watson said. Put another way, Prima determines whether SMA managers have “developed discipline in their investment process to capture market inefficiencies, bring it into the portfolios” and retain it, using methodology “that allows those managers to capture future market inefficiencies as they become available.”
While historical outperformance is “great,” says Watson, “we also look at risk-adjusted returns and relative risk-adjusted returns,” and how well these managers have performed under “different market cycles and in different market conditions.” The process doesn’t end when Prima recommends a manager. “Every quarter, we conduct a holdings-based performance attribution: how much [of that performance] is generated by asset allocation or sector allocation, how much by market timing and trading. What we expect is that the bulk of your alpha will come from your alpha thesis, not asset allocation or sector allocation, not market timing or trading expertise.”
Born in the wirehouses and spurred by the creation of wrap programs, separately managed accounts allow for more customization of a client’s portfolio, better tax planning and allowances for certain restrictions in a portfolio based on the client’s preferences. For higher-net-worth clients, SMAs can be a much more efficient way to access top money managers at a lower-than-institutional-level price point.
“Traditional SMAs remain strong” in the marketplace, but UMA programs “are growing rapidly,” Watson says. Quoting Cerulli data published last year, he says that SMA asset allocations have increasingly favored municipal bond managers at the expense of large-cap value domestic equity managers.
Cliff Stanton (left), CIO of Envestnet | Prima and another member of the selection committee, says bluntly that “any investment is a packaging of risks.” With advisors as Prima’s clients, Stanton’s team focuses on “the risk exposure prevalent” in every manager’s portfolio on which his team conducts due diligence. “We need to convey that to advisors, that this is what you’re getting” with a specific manager. Providing information on “the risks driving returns” in those SMA managers’ portfolios, Stanton says, gives advisors the tools to accurately determine “the risk profile of your [client’s] entire portfolio.”
Prima’s 10 analysts work as a team, adding their individual expertise in evaluating managers, and using returns and holding data gathered by Prima’s data services group. Stanton’s analysts also hold onsite meetings, observing managers’ day-to-day operations at their firms to determine “what are the roles and responsibilities; how are decisions made; what type of overrides exist; or [what kind of] risk management tools are in use to override the decision makers.”
So on a macro level, what trends does Stanton see among those money managers? “What’s becoming more common is what you can characterize as certain factor bets—momentum, high liquidity, high leverage,” he reports. In 2012, he says there were “meaningful differences” in performance between “higher beta, higher volatility stocks” and stocks with lower beta and volatility. High-quality stocks were up 15% in 2012, he says, while lower quality stocks were up 21%. Acknowledging that some advisors “always want a high-quality stock picker while others might want lower quality managers, by having each kind of manager” in a client’s portfolio, “you’re going to ameliorate risk.”
Stanton has seen “a shift in asset flows to equity products again,” though in 2012 there were outflows from equity managed products, mutual funds and SMAs. While Stanton is concerned about those outflows in a year when the S&P 500 was up 16%, he suggests it’s “understandable from a behavioral finance perspective.” As for fixed income—in the SMA world most fixed income money is in munis—he admits that while “return expectations for fixed income are greatly muted,” within SMAs “more customization strategies are possible even in fixed income.”