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When they first appeared, separate accounts were limited to institutions, endowments, foundations, and a handful of individual investors with multiple millions of dollars. For the most part the business was limited to the large wirehouses and of little consequence to most independent advisors. That’s far from the case today, as a variety of new separate account options have come onto the market and an increasing number of investors seek them out.

Across the board, separate account providers are seeing increased demand. While they have captured only a fraction of the assets in the mutual fund market, many in the business expect that ratio to change in the coming years.

“Generally speaking, we see solid growth for separate accounts propelled by a number of factors,” says Mark Spina, a senior VP who heads up business development at ING Investment Management in New York. “One is the greater understanding in the marketplace of separate accounts. Another is the increased interest in transparency and customization that managed accounts offer.”

“The separate account process is on a lot of people’s minds,” says Ross Rogers, president of GlobalBridge Inc. in Minneapolis, who attributes the increased interest to a number of factors, including the market decline of the last few years, the research scandal on Wall Street, and the more recent trading improprieties permitted to occur by some mutual fund companies.

“The industry’s going to go through a lot of change and it’s going to happen probably sooner rather than later,” observes Scott Hamill, managed accounts senior product manager with Russell Investment Group in Tacoma, Washington. Hamill cites Cerulli Associates’ research. “There’s something like $7 trillion in assets in mutual funds,” Hamill says. “There’s about $500 million in separate accounts, but those assets are expected to continue growing at around 15% a year through 2007.” Hamill argues that much of the interest and growth will be driven by investors who want more control over the underlying securities in their portfolios. “If it’s a taxable account, they want the ability to take their gains and losses when it best suits them instead of at the end of the year,” he says, “and they want the ability to get access to their funds on a more efficient basis.”

Among the biggest innovations in separate accounts has been the development of multi-style or multi-asset portfolios and of overlay portfolio management. Hamill explains multi-style portfolios as a mix of different managers put together in one box, and within that box is a “sleeve” for each manager. This allows each manager to be monitored individually and lets the administrator compare those managers’ trading activities to avoid penalties for investors such as those that would arise from violations of the wash sale rule. “In this situation, a Russell person or a Smith Barney person or a Merrill Lynch person could become the overlay portfolio manager,” says Hamill. “These kinds of accounts are not yet a big part of the industry–maybe 5% to 10% of all separately managed account assets–but this kind of oversight is something that high-net-worth people are really concerned about.” That in itself, says Hamill, is reason enough for advisors to get more active in separate accounts.

Coming Downstream

In addition to the benefits offered by increased control and transparency, there are a number of other factors contributing to the growth of separate accounts. Chief among these is the increasing size of the community of very wealthy Americans. According to the recently released 2004 World Wealth Report from Capgemini and Merrill Lynch (see news story on page 18), there are more than 2.5 million high-net-worth individuals in North America, with combined assets in the neighborhood of $8.5 trillion. By 2008, the report predicts these individuals will collectively have some $14 trillion in assets.

Hand in hand with the greater number of HNW individuals are new offerings in the separate account space with lower costs of entry, expanding the number of potential participants even further. Gurinder Ahluwalia, president of GE Private Asset Management in New York, credits this to advances in technology, which allowed his firm last year to introduce a product that offers separate account benefits but only requires a $50,000 account minimum. “The beauty of such products is that by using technology, managers, and the way accounts are melded, you’re able to bring that minimum down significantly. So now with $50,000 you can have an array of international stocks, dividend-paying stocks, and specialty, U.S. core, or growth stocks.”

“The appeal has broadened from ultra-high-net-worth and high-net-worth to the mass affluent market,” agrees Spina, “but there’s also a floor on which these services are feasible. We think it’s a mass-affluent- and-up type of product.”

Of course, not every firm is looking to come as far downstream as Ahluwalia’s. For Rogers of GlobalBridge, the appropriate individual investor for a separate account has between $750,000 and $1 million at the floor and possibly as much as $20 to $25 million. “That’s really the appropriate place to think about separate accounts,” he says. “The demographics will bear out that there are a whole lot of millionaires in this country. A lot of them are thinking about ways to have their money effectively managed as their life expectancy expands.”

The Advisor’s Role

So far, the independent advisors who have embraced the separate account space are few in number, only around 5%, according to studies by Tiburon and others. “You see the independents making some inroads, but it’s been slow and gradual,” says ING’s Spina. The wirehouses do an excellent job serving the client and delivering competitive offerings to their financial advisors.” He adds that those just coming into the managed account marketplace are reaping the benefits of products developed in the last few years, such as multi-asset portfolios that provide clients with “a single, one-stop solution for large blocks of their investment allocations.”

“Investment advisors have two paths they can go on,” points out Ahluwalia. One is to act as the fiduciary and be the money manager. The other is to hire an asset management firm to be the fiduciary and let the firm choose the managers and monitor performance. That allows the advisor to spend more time working directly with the client, to understand her specific needs, and to establish a long-range plan, including a risk management strategy.

“One of the major trends in the advisor marketplace right now is a strong and growing focus on managing the relationship with the client as opposed to managing the assets themselves,” agrees Rogers of GlobalBridge. “That’s really the place where the advisor can add the greatest value. The really good advisors know the client inside and out and help fit investment products to the dreams, aspirations, and needs of the client.” Rogers says advisors have also been prodded by their clients to get into separate accounts.

The advisor community’s slow acceptance of separate accounts is understandable, say most observers. “I think that for some advisors, the hard part is giving up control,” says Hamill, noting that once they get a little more comfortable with the managed account concept, most advisors realize that their most important task is to put together the client with the best investment vehicles. With all the transparency in separate accounts, however, advisors do have to make sure the client understands what they’re looking at. “With a mutual fund, there’s trading going on every day. With separately managed accounts, the investor gets to see what’s going on under the hood. A lot of investors see all this activity, which they’re not used to, and that spooks them,” he says. Furthermore, Hamill says, a key part of the advisor’s role is to make sure the clients give the separate account manager enough time to let his style work.

“Going forward, advisors need to realize that there will be a growing number of clients that want this product,” says Hamill. “They have to either learn to handle this product or be willing to turn clients away. Whether they like it or not, like a snowball rolling down a hill, it’s coming at them.”

Staff Editor Robert F. Keane can be reached at [email protected]


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