While there are some 5,000 separately managed account products in the market, not all are “considered legitimate SMA management firms for managing an advisor’s client capital,” according to Prima Capital Holding President J. Gibson Watson III. “Of this universe, Prima estimates that there are about 1,400-1,500 SMA products managed by 600-700 firms that are suitable for high-net-worth investors,” according to Watson. Even whittled down to a mere 1,500 accounts, the task of sifting through all that’s available to find the best can be daunting.
To give advisors a head start on that heavy lifting, Standard & Poor’s, Prima Capital, and Investment Advisor have teamed up for the third year to find the most outstanding separate accounts and their managers, and recognize them with the 2007 Separately Managed Accounts Awards. Prima Capital’s Senior Analyst Nathan Behan and a Denver-based team of investment analysts culled through scads of data in the S&P/Prima Capital SMA Evaluator (available at www.primacapital.com), to select nominees, all of which had assets of $200 million or more, lead-manager tenure of three years or more, are widely available through retail programs, and rank above average in at least four of five SMA Evaluator categories.
A committee including Philip Edwards, managing director of Standard & Poor’s Investment Advisory Services; Prima Capital Holding President Watson; IA Editor-in-Chief Jamie Green, and IA Senior Editor Kathleen McBride selected the award winners with the assistance of Prima’s insightful analysts.
This year there are seven winners in six categories. For the second year in a row, Appleton Partners wins for best Fixed-Income account, and KCM Investment Advisors wins in the Tax Efficiency category with its Large-Cap GARP Equity account; for the third year, Thornburg Investment Management wins in the Large-Cap U.S. Equity category, with its Thornburg Value Equity account. The Large-Cap category has another winner, TCW Investment Management for its Relative Value Large Cap portfolio. Insight Capital Research and Management’s Small Cap Growth product is the winner in the Small-Cap U.S. Equity category; Geneva Capital Management’s Mid Cap Equity wins in the Mid-Cap U.S. Equity group; and in International Equity, this year’s winner is AllianceBernstein’s International Value ADR.
More Assets, Wider Availability
Assets under management in SMAs grew to $805.8 billion, up 24.8% year over year, at the end of the third quarter of 2006, the latest data available, according to the Money Management Institute (MMI), which estimates that those assets were stashed in 2.52 million accounts. MMI expects separate account AUM to top $1 trillion by 2009 and $1.5 trillion by 2011. According to Cerulli, which breaks out assets invested via platforms versus those brought to a separate account manager directly by an advisor, the average separate account via a platform in 2006 was $334,000, but there were an average of three allocations per client, so the average represents in reality a $1 million client relationship. The average for assets brought directly to the SMA manager was $1.183 million.
Part of the rapid expansion of SMAs available to advisors can be attributed to the popularity of “overlay managers, which provide even more efficiency to the trading so you don’t have one manager selling IBM while another manager is buying it,” says S&P’s Edwards. That’s a catalyst for growth, he says, and also allows consolidation of “something as seemingly minor as account statements,” but which is a major convenience to clients. There’s more access to SMAs, he says, because of platforms like Lockwood Investments, which offers the accounts “over their platforms, and I do think that gives independents access almost on an equal footing with the wirehouses.”
The fee structure is changing for managers along with the platform structure. The advent of model portfolios is changing the operations structure of the SMA market, making the cost lower to investors but squeezing fees earned by the managers who participate. Still, there has been “fairly steady adoption of model-based, multi-manager programs by sponsor firms,” Prima’s Watson explains. It is “somewhat of a departure from a traditional SMA platform, because rather than manage individual sleeves in the portfolio, the manager submits his portfolio holdings to a sponsor or to an overlay portfolio manager to facilitate trading across the sleeves of the portfolio or across the different accounts.” Along with outsourcing trading and operations, SMA managers are outsourcing the one-on-one contracts they have directly with advisors and clients to omnibus contracts with the platforms. That eliminates a lot of administrative work, but it also contributes to margin pressure on separate account managers who have had to cut their fees accordingly. “It tends to be a somewhat more tax-efficient, lower cost, more consolidated reporting type of experience for the client, yet not all managers are willing to participate in these types of programs,” notes Watson. “They de facto are giving up their intellectual property, giving up these portfolio holdings for that third party to trade on their behalf, and they’re giving up a lot of that back-office responsibility. Depending on the [type of] business that they’re in, the managers may not be willing to sacrifice that intellectual property,” says Watson.
If a manager generates alpha by “making asset allocation decisions, sector selection decisions, individual security selections, or based upon their trading or market timing–if you’re giving up your trading or market timing abilities to a third-party firm–plus you’re giving up your securities selection, or at least making it public,” Watson asks, “do you risk giving up your ability to add alpha in your portfolio?”
Our winners, however, have sidestepped that pitfall and others, exemplifying excellence as measured by high, consistent returns, strong levels of customer service and customization, and widespread availability. Here are individual profiles of this year’s SMA Awards winners.
Large-Cap U.S. Equity
Thornburg Investment Management
Thornburg Value Equity
Thornburg Investment Management Value Equity
Web Site: www.thornburg.com
Standard: Minimum Investment $25 million
Product Assets: $8.2 billion
Benchmark: S&P 500
1-year return vs benchmark: 22.76% vs 15.80%
5-year return vs benchmark: 9.06% vs 6.19%
Separating equities into basic value stocks, consistent earners, and emerging franchises has always been the modus operandi of Bill Fries and the investment management team of Thornburg Value Equity, and in 2006, this strategy scored them several winners, including the stocks of Las Vegas Sands, a casino operator in the U.S. that is making good with its investments in Macao.
The team also invested in the shares of satellite television operator DirecTV. “We thought it was a consistent earner because of the nice monthly checks the company gets from its customers, which provide a steady revenue stream,” says Connor Brown, co-portfolio manager of the value equity product, who together with Ed Moran, was promoted to this position last February. “We don’t hold it anymore, though, because it hit our price target.”
A core part of the Thornburg approach is to buy stocks when they are out of favor, says Bill Fries, who has headed the value equity strategy since its inception in 1995. He gives as an example the retail pharmacy chain Rite Aid, which was never a hot market favorite because it has always had a much smaller market capitalization than rival pharmacy giants Walgreens and CVS. In 2006, though, Rite Aid acquired a couple of Canadian pharmacy chains, a move that has given the chain almost as many stores as its larger competitors and increased its attractiveness to investors.
A large part of Thornburg’s success in this area is keeping client portfolios sharply focused. “We have less than 50 names in our SMA strategy, and we believe that having a limited number of names that we know well is key to our success,” Brown says.
“Each of us is a global generalist,” he says. “We are looking at different stocks and industries all over the world, so I feel we get a better perspective on things than other shops were analysts are more specifically oriented.”
There are 10 investment professionals in the Thornburg Value Equity product and they manage around $8 billion in both institutional and individual accounts.–Savita Iyer
TCW Investment Management
Relative Value Large Cap
TCW Investment Management Relative Value Large Cap
Web Site: www.tcw.com
Manager: Diane Jaffee
Standard Minimum Investment: $5 million
Product Assets: $14 billion
Benchmark: S&P 500
1-year return vs benchmark: 19.90% vs 15.80%
5-year return vs benchmark: 12.30% vs 6.19%
Diane Jaffee, who manages $14 billion in relative value large-cap stocks for TCW, invests using the motto “searching for value, poised for growth.” As such, she is not only looking for relative value in equities, but also seeking a fundamental catalyst to unlock that value, and drive strong cash flow for a company.
Jaffee, who has been with TCW since 1995, has three criteria for unearthing those catalysts.
First, she looks for restructuring or cost-cutting measures. Second, she looks to see whether a company is launching a new product or entering a new market, the success of which could contribute to top-line growth. Finally, the presence of a new management team–a new CFO, for instance–with different ideas on how to move a company forward, also can spur cash flow.
“We’re first identifying value and then the fundamental catalyst that will make the stock attractively valued and poised for growth,” Jaffee says. TCW has six analysts dedicated to this strategy, several of whom have significant investment experience.
Jaffee also prides herself on portfolio construction, which is done with the goal of minimizing three important risks: market, or specific risk; individual stock risk; and sector risk. “There have been lots of historical and statistical studies that show that if you have a large-cap portfolio of 26 names or more, you minimize 95% of your specific risk,” she says.
Jaffee also builds channels around sector weights in her portfolios, and the maximum initial position on any stock she includes is 1%. Only as she gains conviction that the stock indeed is doing what she wants it to will Jaffee increase that allocation to between 3% and 4%, and she will automatically start scaling out as soon as any stock appreciates by 5% above market, because “we do not want the tail to be wagging the dog.”
But Jaffee places the greatest importance upon the relationship she has with her clients. “I do believe that clients come first, and I think that the better you know your clients, the better your results will be for them,” she says. “I or members of my team are in close contact with our clients.”–Savita Iyer
Small-Cap U.S. Equity
Insight Capital Research and Management
Small Cap Growth
Insight Capital Research and Management Small Cap Growth
Web Site: www.icrm.com
Standard Minimum Investment: $100,000
Product Assets: $249.8 million
Benchmark: Russell 2000 Growth
1-year return vs benchmark: 19.01% vs 13.34%
5-year return vs benchmark: 20.42% vs 6.92%
With small cap, whether you are looking at separate accounts or mutual funds, it can be frustrating to see a portfolio that looks interesting, only to find it closed to new investors. Fortunately, the winner for small caps this year, Insight Capital’s Small Cap Growth, has room to grow. With $590 million in assets in the portfolio as of December 31, the managers estimate that it can double to $1.2 billion in assets before reaching capacity.
Insight’s team manages the portfolio using fundamental analysis along with quantitative screens. Another characteristic that sets the portfolio apart is that the team does not always overweight traditional growth sectors like IT and healthcare.
Portfolio Managers Lee Molendyk and Lance Swanson, both vice presidents based at the firm’s Walnut Creek, California headquarters, run the portfolio with a three-step investment process that’s quantitative and qualitative. The investment process is “very bottoms-up, fundamentally driven, but we do start with a quantitative screening process as our way to weed out some non-performing stocks,” according to Molendyk. They look for “high-alpha, low-standard-deviation stocks as indicators of potentially positive fundamentals.” Starting with “all the stocks that publicly trade,” in the U.S. at more than $2, about 6,500 companies, they “sort those every night with a proprietary tool,” whittling the universe down to about 400 small-cap companies.
The team spends most of its time on the fundamental analysis of the remaining 400 stocks, looking for “well-managed growth companies [with] sustainable sales and earnings growth,” Swanson explains, and market leaders.
Once a stock makes it onto the buy list, he says the team watches “its price performance, making sure as news and data comes out it is as expected and the stock reacts positively to it.” Typically, the managers hold around 40 “relatively concentrated positions,” ranging from 2% and 4%, and they never buy over a 5% weight in the portfolio. “Being that concentrated, weights can move around rather quickly,” Molendyk reports, “so we find ourselves trimming quite a bit, and putting those [assets] into new names.” That trimming can lead to relatively high turnover, on average around 200% per year. As for customization, as Molendyk puts it, “we have strategies for clients with strict cash control restrictions, sector restrictions, we even have a socially responsible client; we can tailor it to whatever a client needs.”–Kathleen M. McBride
Mid-Cap U.S. Equity
Geneva Capital Management
Mid Cap Equity
Geneva Capital Management Mid Cap Equity