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An SMA for 401(k)s

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Envestnet Asset Management recently launched ENVEST(k), a turnkey platform for qualified plans that allows participants with smaller account balances to invest in separate accounts.

This is good news because separate account minimums have traditionally been pretty high, with clients needing to be at least semi-affluent investors to get into them. Providers have been grappling with the question of how to offer the benefit of separate accounts to a 401(k) plan where the plan participant’s balance may only be $20,000 to $30,000, says Viggy Mokkarala, executive VP at Envestnet.

ENVEST(k) solves this problem by lumping together participants with similar balances and risk tolerances to achieve a higher overall balance that’s suitable for a separate account.

Let’s take a firm that has 100 participants in its 401(k) plan. Say 25 of the participants choose a moderate growth portfolio and each has $30,000 in their 401(k) plans. If you combine the 25 accounts, you get a total balance of $500,000, Mokkarala says, “and that’s enough to run an asset-allocated portfolio.”

Traditional retirement plans have provided participants with a selection of mutual funds, allowing them to pick and choose among those funds. But study after study has shown that most participants lack the knowledge to choose appropriately. Plan providers have been reacting to this by offering managed accounts using mutual funds, like a mutual fund wrap portfolio. ENVEST(k) “takes this concept even further by saying there are some very natural benefits in separate accounts versus mutual funds,” Mokkarala says. “We’ve put together asset allocated portfolios using institutional-class money management firms, and are offering those in the retirement space.”

ENVEST(k) uses Envestnet’s Multi Manager Account portfolios, actively managed mutual funds, and ETFs, and is designed for defined benefit and defined contribution plans, like 401(k)s and 403(b)s. Mokkarala says a managed portfolio gives investors peace of mind because, unlike mutual funds, they are being “continuously maintained and monitored” for plan participants.

Separate accounts are gaining in popularity because they tend to be less expensive than mutual funds, and are more tax efficient. According to fund guru John Bogle, chairman of Vanguard, the average domestic actively managed no-load mutual fund has an expense ratio between 140 and 150 basis points, Mokkarala says. “If you were to take that number before you add any costs of trades, or costs of asset allocation and modeling, you will find ENVEST(k) offers a very competitive solution,” he says.

The cost of the ENVEST(k) platform plus investment management fees are 80 basis points for aggregate plan assets up to $5 million, Mokkarala says. When plan assets exceed $20 million, the fee drops to 60 basis points. Envestnet also levies a “small trading fee” as well as a custody and clearing fee, which varies depending on plan assets. There are also third-party administrator fees, which also vary depending on plan assets and number of participants.

When Mokkarala fields queries from advisors about how ENVEST(k) compares to other providers, he compares their current costs to fees levied by Envestnet. “We usually compete very effectively,” he says.

Joe Michaletz, a planner with Michaletz and Jacobs Wealth Advisory Group in Mankato, Minnesota, says that while some other companies are offering separate accounts in qualified plans, none of them are as flexible as ENVEST(k). “The ENVEST(k) program provides a very efficient platform for RIAs to work within the 401(k) marketplace,” allowing RIAs to bring a fee-based platform of separately managed accounts, mutual funds, and ETFs into a 401(k) platform.

“ENVEST(k) is unique,” claims Michaletz, “because the administration of a 401(k) platform is pretty easy when using mutual funds, but complex when you have a multiple-asset-class portfolio with multiple managers.”

Envestnet recently merged with Oberon Financial Technology, a Silicon Valley-based company providing application software and services for wealth management.

Using separately managed accounts in 401(k) plans is a trend that’s only going to gain steam because they are more “functional” than mutual funds, Michaletz argues. “People are realizing that mutual funds have some inherent conflicts of interest, lack [complete] fee disclosure, and most mutual fund companies take an anti-fiduciary stance with the 401(k) sponsor.” Another advantage in using separate accounts is that they constitute “much smaller asset bases,” he points out. “When you look at the ability for managers to move in and out of markets without being restricted due to capacity, separate accounts’ [small asset base size] offers tremendous flexibility and downside protection.”

The separately managed account managers that Michaletz uses “have substantially lower betas and risk/return profiles compared to their similar asset-class style counterparts, while at the same time providing alpha.”

The big mutual funds with $40 to $50 billion in assets also have a hard time liquidating their largest holdings without negatively impacting the price of those stocks, Michaletz says. It can take large mutual fund managers six months to even a year or more to liquidate their largest holdings, he says. With separate accounts, “we constantly monitor our managers to make sure their largest holdings won’t take more than five days or less to liquidate,” he says. “That’s a big difference.”

Envestnet is now marketing ENVEST(k) to large independent broker/dealers, and has rolled it out already to Securities America and Transamerica’s networks of advisors.

With ENVEST(k), advisors “are able to sit down with the company whose 401(k) plan he/she is going to run,” and advise plan participants on their investment needs, retirement horizon, and so forth, Mokkarala says. Advisors can hold clients’ hands through the entire asset allocation portfolio, “helping them with their investment selection up front.” This allows the advisor to form binding relationships with the employees, “and at the time the employee either retires or moves on and takes rollover assets with them, the advisor has an advice component as a part of the service they are delivering.” Five years from now when the baby boomers start to retire, rollover assets will make up 40% of investor dollars, so capturing some of that money is going to be important for every advisor.

Washington Bureau Chief Melanie Waddell can be reached at [email protected]