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Salad Days

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Separate accounts are soaring. A snapshot of the last six years shows assets under management in these accounts have quadrupled, blossoming from a little under $75 billion at the end of 1994 to $275 billion by March 2001, and are likely to surpass $650 billion by the end of 2005, according to a new report by Cerulli Associates.

In its latest report in The Cerulli Report series, Asset Management: The State of the Separate Account Consultant Programs, the Boston-based firm also found that the overall size of the managed accounts industry reached $727.8 billion in assets by the end of the second quarter. This figure represents an 0.62% growth rate over the first half of 2001, and a healthy increase of 8.85% over the $668.6 billion recorded at the end of the first quarter, Cerulli says. In comparison, over the first six months of 2001, long-term mutual funds saw a decline of 4.07% while the Wilshire 5000 index fell 5.79%, showing that investors have maintained their interest in managed accounts despite lagging mutual fund growth and drooping equity markets.

More and more asset management providers are offering separate accounts because they quench affluent clients’ thirst for customized, tax-efficient vehicles. Just this year, SEI Investments and the Boston-based distribution firm Sincere & Co. ventured into the separate accounts business, and Fidelity Investments expanded its separate account management program to include individual fixed-income securities as part of an overall asset allocation strategy through Private Portfolio Services. SEI launched its program in April, and by July experienced inflows of $500 million. In June, Sincere & Co. launched its private-labeled, Internet-based, turnkey managed accounts platform exclusively for fee-only RIAs, featuring a select group of respected money managers representing a variety of investment styles.

Unlike other providers, Richard Sincere, president and CEO, says his firm is weeding out undesirable portfolio managers by using returns-based analytical software from Markov Processes International Corp. called mpi Stylus Pro. The software screens a manager’s investment style, efficiency, and competitive position against his peers. In developing the platform, “I saw that a number of firms were going to make the same mistakes that they made with mutual funds, that they were going to have open architecture and open their doors to a number of firms,” Sincere says.

He says other firms are choosing money managers based on the size of the firm and the amount of assets they can bring to the table, instead of using returns-based or quantitative analysis. Sincere says he’s also going to limit the number of money managers on the platform to between 20 and 25, to include only those that have gone through quantitative and qualitative analysis. “We will get the names we’re looking for by September or October,” he says.

For its qualitative analysis, Sincere says the firm plans to hire a well-known industry veteran who’s been in the investment management business for 27 years, and who’s chairman of a major corporation, to perform the qualitative analysis. He declined to name the individual. “I had been interviewing managers, but I decided to move it up a level,” Sincere says.

Besides being able to choose from a nationally ranked list of money managers, RIAs, upon agreement, can add managers with whom they have an existing relationship. RIAs can also choose to custody assets with Fidelity, Schwab, TD Waterhouse, and Pershing. Other custodians will be added as well. Sincere’s platform also enables investors to access separate accounts at a lower minimum of $100,000, depending on the manager. Another benefit is that the managed accounts’ Web sites are private labeled and carry the planning firm’s moniker.

Viggy Mokkarala, an Oberon Financial Technology, Inc., founder and VP of marketing and business development–the Sunnyvale, California-based firm responsible for developing Sincere’s technology platform–says the firm is working on new optimization tools that will allow advisors to customize a client’s account for tax purposes, cash management needs, and security restrictions. “The advisors have an advisor console where they could be tweaking the investment policies of a client on an ongoing basis,” Mokkarala says. “You could get in [to the console] and say, ‘My customer’s situation has changed. His wife has bought a bunch of Cisco stock, and I don’t want that to be purchased anymore in my client’s account.’ The advisor would go online and make all those specifications and they would be reflected operationally in the client’s account. [Advisors can] optimize [the portfolio] for other holdings, and therefore that would be translated into security restrictions that the portfolio would have.” He says these enhancements are being beta-tested now, and will be demonstrated at the Financial Planning Association’s annual meeting in San Diego, which starts September 13.–Melanie Waddell

How Are We Doing?

A report culled from online ADVs yields some interesting tidbits about the profession

Unless you’ve been engaged in a leisurely stroll across the Himalayas the past few months, you’re aware that the SEC’s scheme to file and maintain Form ADV data on the Internet is alive and well as the elaborate electronic filing system known as IARD (Investment Adviser Registration Depository). For those who’ve forgotten IARD’s purpose and are eager for early system results, a new report details all.

“Evolution Revolution: A Profile of the U.S. Investment Advisory Profession,” is a collaborative effort of National Regulatory Services and the Investment Counsel Association of America. The July report notes that SEC rules issued last year calling for a Form ADV overhaul also require advisors to make filings of the revised Part I of Form ADV via IARD. IARD is designed to benefit advisors and the public alike. Consumers are given free access to vital advisor information drawn from these filings, enabling them to judge the relative merits of advisors. As for advisors, IARD is meant to ease some of the regulatory busywork by permitting electronic filing.

The report covers the 6,649 federally registered investment advisors who held $18 trillion of discretionary assets as of May 1, 2001.

While some of the data is amusingly ambiguous–for example, 251 firms report having zero clients while 67 of those firms report having assets under management–there’s much of interest. Most investment advisory firms, we learn, are relatively small: 3,092 (46.5%) firms have only one to five employees; and 1,297 (19.5%) investment advisors have between six and 10 employees. As for who does what, 4,226 (64%) firms have one to five employees who perform investment advisory functions; and 1,037 (16%) advisors employ between six and 10 individuals to do the same. Also: 2,371 (36%) of investment advisors are affiliated with broker/dealers; 1,385 (21%) with investment companies; and 2,338 (35%) with other investment advisors.

The free report is available at–Cort Smith

All the President’s Men

Two recent Bush administration appointees are of particular interest to advisors. The first is New York securities lawyer Harvey Pitt as chairman of the Securities and Exchange Commission. Pitt was confirmed by the Senate August 1 and sworn in at a private ceremony a week later.

It may seem ironic that the same man who represented Ivan Boesky will assume the role of chief Wall Street watchdog. Yet the appointment was hailed by many as a good choice. Financial Planning Association President Guy M. Cumbie’s reaction was typical: “The FPA is pleased that someone with his impressive knowledge and expertise in the practice of securities law has been selected to lead the SEC in a time of incredibly rapid changes in the financial services industry.”

Indeed, most who voiced an opinion on the appointment coupled their remarks with mention of the hefty task facing Pitt. Advisors in particular will be watching Pitt’s actions on the so-called Merrill Lynch rule. That proposal, first floated in November 1999, would allow brokers offering extensive financial planning services the liberty of not registering as investment advisors with either the SEC or the state. Thus far, Pitt has only said that he will approach all topics with an open mind. The FPA has already asked to meet with Pitt to discuss the topic.

The second appointment involves Hector Barreto Jr. of Los Angeles as administrator of the U.S. Small Business Administration. Barreto is a broker and a long-time member of the National Association of Insurance and Financial Advisors. Last year alone, the SBA guaranteed more than $10 billion in loans to more than 43,000 small businesses.–Mike Jaccarino

Back to School

Despite the democratization of investing, a survey shows that consumers still need schooling

A recent survey conducted for the Securities Investor Protection Corporation and the National Association of Investors Corp. found that 85% of U.S. investors do not know enough to pass a “survival” investing quiz. The five-question test–given by phone to 2,067 adults across the U.S. in late May and early June–was meant to gauge investors’ ability to handle their finances in times of market downturns, to combat investment fraud, and to deal with problem brokers.

“We did find it disturbing that these fairly easy questions weren’t dealt with very well by the majority taking the test,” says Stephen Harbeck, general counsel of SIPC. “Eighty-five percent of investors surveyed didn’t get three of five answers correct.”

Among the key findings: Almost two in three investors do not know what to do when they suspect they are dealing with a problem broker. More than four in five investors do not understand how margin calls work. And fewer than one in five investors realizes that there is no insurance against market downturns or market fraud. “One-third of investors thought the SEC would provide insurance against market losses,” says Harbeck.

The only question that was answered correctly by a majority (59%) of those surveyed was choosing the correct description of Chapter 11 bankruptcy


“If Americans are going to shift from a nation of savers to a nation of investors they need to know the language of Wall Street,” says Harbeck. “For instance, they need to know the use of limit orders and margin calls. Investors need to know these things so they don’t get taken advantage of.”

Nan Mead, director of communications for the National Endowment for Financial Education, sees investment advisors as playing an integral role in the learning process.

“The first line of defense for consumers seems to be financial planners,” she says. “I’ve heard a lot of planners say that people come in about their insurance needs and tax status and they’ve thought about ways to save money on taxes, but when it comes to investing, they’re at a loss. The planners do seem to spend a great deal of time educating clients or potential clients. So if there is any kind of education system in place, although it is very informal, it is the financial planners. I think it would be very helpful if there was a program planners could use to work with clients in a more formal sense, or that organizations could use for their employees, but nobody has stepped forward.”

David Martula, a planner from Hadley, Massachusetts, says educating investors “makes for better clients. It makes everyone feel more comfortable. It’s difficult to teach, though.”–Josh LeBaron

Online CD Deals

How does a 5.5% percent yield on a one-year certificate of deposit grab you? Or a money market account with 4.9% annual interest rate? If such comparatively lofty returns on risk-free investments sounds good, you should visit allows its users to survey rates from more than 4,500 banks and financial institutions across the U.S. on financial products like CDs, money market accounts, and savings accounts. “Why settle for what your local banking institutions are offering when you can find the best rates in the country?” asks Robert DeFranco, a senior VP at “You can really do well for your clients.”

DeFranco says the company has 38 employees devoted entirely to surveying banks across the country and making sure that no dynamite yields are lost in the shuffle. “When you pull up the 100 highest yields, I’m pretty confident that that is an accurate list,” he says.

While the information is Web-based, the North Palm Beach, Florida-based information company has been around since 1976, publishing several newsletters, including The Bank Rate Monitor.

Similar nationwide comparisons are performed by other sites, like Banxquote at Banxquote has 12 employees surveying 400 banks and financial institutions across the

country.–Mike Jaccarino

Mortgaging The Future

What you should know about mortgage-backed securities

Consider this hypothetical situation: An advisor sits down to create an asset allocation plan for a client and figures on somewhere around a 7% annual return for the fixed income portion of the portfolio. This would be logical, the advisor figures, since most of the literature he has read quotes the performance of historical bond indexes in that area.

Then he neatly allocates 20% of that portion of the portfolio to long-term U.S. Treasuries, 20% to intermediate governments, 20% to short-term Treasuries, and 40% to corporate debt. He rubs his hands together in a self-satisfied manner and calls it a day.

What’s wrong with this picture?

The main thing that’s wrong, says Scott Simon, a fund manager for PIMCO Funds, is that the advisor has figured on a 7% annual return from the bond portion of the portfolio–based on the historical performance of most major aggregate bond indices–and then failed to account for an asset that constitutes a preponderance of those indices. The asset that Simon is talking about is mortgage-backed securities (MBS). It’s a little known fact that MBS make up anywhere from 30% to 40% of most major aggregate bond indices like the Lehman Brothers Aggregate Bond Index (35.6%) and Salomon Smith Barney U.S. Broad Investment Grade Index (33.8%). “If you’re playing bonds in an asset allocation model and you ignore mortgages, you are ignoring 40% of what makes up the indices and thus are taking an enormous risk that your asset allocation will not perform correctly,” Simon says. “This is an example of dangerous asset allocation.”

Indeed, extend the hypothetical situation a few years into the future: The advisor has counted on 7% to 8% from the bond portion of the overall portfolio–in accordance with the historical performances of most major aggregate bond indices–and then only achieves 4% to 5% by not having included mortgages in the bond allocation. “This can have disastrous consequences for a person’s retirement depending on how much of the total portfolio was put into bonds,” Simon adds. “You can’t ignore mortgage-backed securities.”

Yet Simon as well as a host of other advisors and asset allocation software technicians interviewed for this article agree that this mistake is more common than one might think. “My gut says that not many know that that much of the aggregate bond indexes are devoted to them,” says Thomas Orecchio of Greenbaum & Associates in Oradell, New Jersey. Adds Patricia Houlihan of Cavill & Company in Oakton, Virginia: “I think this happens.”

Then there are those who fall into trouble with their asset allocation and portfolio optimizer software. Take, for instance, NaviPlanner, the software from Emerging Information Systems Inc. (EISI). NaviPlanner offers no default asset classes, relying entirely on the advisor to choose the ones he would like to include in an asset allocation plan. The advisor must also input his own data for historical returns, opening himself up to the mistake of quoting the performance of aggregate bond indexes without taking into account mortgage-backed securities. As advisor Peggy Ruhlin of the Columbus, Ohio firm Budros and Ruhlin points out, “Your optimizer is only as good as the data that you put into it.”

A less egregious mistake is made by those advisors who choose to neglect mortgage-backeds entirely in favor of more conventional corporate and federal debt. This might not be as dangerous to the client, but it’s still a missed opportunity.

As a final point, an advisor might want to ask himself why he is so gung-ho on Treasuries, rather than MBS. Agency mortgage-backed securities–those from Freddie Mac, Ginnie Mae, and Fannie Mae–are guaranteed even if the homeowners default on their loans. And the long bond actually has a great deal more sensitivity to a rise in interest rates. “People think that because of the higher yield, there is much more risk,” Simon says, “while really it’s only because of the pre-payment risk [from refinancing and home sales] and when interest rates fall, MBS are a little slower to rise in value. One of the reasons PIMCO has been so successful is because we have been overweighted in this asset class.” Despite this, only 1.3% of MBS were owned by individuals, according to Salomon Smith Barney. Simon wonders when advisors will learn.–Mike Jaccarino


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