SMAs continue to win over advisers despite drop in growth

In the midst of a pause in a decade-long growth spurt, the separately managed accounts industry continues to win over independent financial advisers, many of whom are generally wary of the products’ complexity.

“For someone like me who fancies himself a holistic wealth manager, I wanted to offload the asset management and be able to spend more time working with clients,” said Dan Juechter, president and chief executive of Hunter Financial Advisors Inc. in Tarrytown, N.Y.

Mr. Juechter, whose firm oversees $85 million in client assets, said that many of the distinctions between mutual funds and separate accounts initially confused some of his clients when he started making the transition from funds five years ago.

“It was not easy, and it required a re-education process because there are so many moving parts within separate accounts that allow for the customization,” he added.

Although wirehouse brokers have been the early adopters and biggest fans of separately managed accounts, the advisory market has long been seen as a crucial component in the industry’s continuing growth and success.

The SMA industry stands at about $700 billion. According to the Money Management Institute’s latest data, which were compiled by Dover Financial Research in Westwood, Mass., the growth rate has slowed over the past few years and actually declined by 9% during the first quarter to $694 billion.

SMA assets rose by 7% last year to $765 billion, by 15% in 2006 to $713 billion, by 14% in 2005 to $620 billion and by 24% in 2004 to $543 billion, according to Dover.

“We think the separate-accounts industry has followed the market,” said its managing principal, Jean Sullivan.

“But we also know that the growth has stalled in many of the legacy programs,” she added. “There’s a shift away from single-product platforms and toward multiproduct platforms.”

The multiproduct evolution includes the wider use of unified managed accounts, of which separate accounts are only one of many investment strategy options.

Despite the recent drop-off in assets, which is partially attributable to market conditions, SMAs are expected to continue building momentum as a solid and substantial component of individual investor portfolios, according to some of the industry’s biggest proponents. They maintain that the advent and continuing adaptation of the UMA platform, which brings together multiple investment strategies into a single portfolio, lay the foundation for a strong case for separate accounts.

Many advisers, however, perceive SMAs as an overly complicated variation of the traditional mutual fund.

“I’m not a fan of separate accounts,” said Daniel Traub, vice president of wealth management client services at Braver Inc.

“I’ve heard all the arguments of how they are tax-efficient and -better-performing than mutual funds, but I don’t see how they’re any better than mutual fund indexes or exchange traded funds,” said Mr. Traub, whose Newton, Mass.-based firm oversees $400 million in client assets.

The main appeal among advisers and clients, he said, is the “cachet” effect.

“Some people might think it’s kind of neat to be invested in a separate account, but that’s not a financial reason to do it,” Mr. Traub said.

For some advisers, the details that come with the customization are part of the headache of using SMAs.

“I find that clients don’t like the daily trade confirmations they end up getting with separate accounts,” said Scott Snow, owner of Scott Snow (financial advisors) LLC, a Westlake, Ohio, advisory firm that oversees $244 million for clients.

“If you’re looking for an extremely tax-efficient portfolio, we might use a separate account,” he added. “But it’s a lot cleaner and quicker to get out of a mutual fund; it could take weeks to get out of a separate account investment.”

Perspectives like those shared by Mr. Traub and other advisers reflect the extreme end of the spectrum, and possibly a segment that will never warm up to separate accounts, according to Christopher Davis, executive director of the Washington-based MMI.

“For some advisers, their value proposition is helping the clients pick the funds or ETFs, while others like to leave it to the pros by picking the money managers,” he said. “Separately managed accounts are appropriate for investors who want a high degree of customization; they don’t want to be picking securities, and they don’t want their advisers picking securities.”

MAKING INROADS

SMAs were created more than 30 years ago as a way to provide individual investors with access to institutional-quality money managers. However, they have always been among those investment strategies characterized as being sold and not bought, meaning that there is very little investor demand.

Despite some of the more vocal criticism, the industry has made inroads into the independent-adviser channel.

The ability to customize for tax purposes or general investment preferences is what initially drove Houston-based adviser Keith Huff toward separately managed accounts.

“When you’re using separate accounts every client is a candidate for tax loss harvesting,” said Mr. Huff, president of Hollis Huff Lewis & Co. “In the current market conditions, with both gains and losses in the portfolios, we’re going to be turning lemons into lemonade.”

Since he started using separate accounts for his clients in 2003, Mr. Huff has transitioned about 70% of the $100 million in client assets from mutual funds to separate accounts.

Much of the satisfaction of advisers such as himself can be attributed to the evolution of the SMA industry, which has become increasingly automated, with more efficiency, less paperwork and account minimums as low as $25,000.

The tax management aspect alone should be enough to convince advisers at least to take a closer look, according to Michael Bell, president and chief executive of Denver-based Curian Capital LLC, a $3.5 billion managed-account platform.

“About half of our taxable ac-counts were harvested for tax treatment last year,” he said. “We have shown advisers the reasons to look at separate accounts.”

Mr. Bell cited the record $34 billion in capital gains and dividend payments by mutual fund investors last year as a slam-dunk case for SMAs, which are marketed for their ability to help investors minimize their tax burden.

According to Lipper Inc. of New York, the $600 billion of capital gains and dividend distributions to mutual fund investors last year that generated the record-level tax hit shaved between 1.3% and 2.2% off the performance of the average mutual fund last year.

“People are being stung by the taxes in mutual funds, and that has opened peoples’ eyes to look for a better way to invest,” Mr. Bell said.

MARKET PENETRATION

The reason penetration among all financial intermediaries remains at an estimated 28% of the industry — the vast majority of which is concentrated within the wirehouse firms — is often attributed to a lack of industry education and adviser sophistication.

“Mutual funds are yesterday,” Mr. Davis said. “And a lot of the fee-only planners are ultra-independent, and they’re not getting the training, because they’re really in their own world.”

The general thinking is that separate accounts will gain additional traction in stride with the increased popularity of UMAs, which is all part of the MMI’s expanded focus to include all investment products as part of its new emphasis on investment solutions.

This is the closest that the industry has come to reaching out to the fragmented universe of independent financial advisers, which helps to explain some of the debate and confusion over the details and benefits of separate accounts.

“I think separate accounts are a tremendous opportunity for investors, and it does surprise me that you would hear otherwise,” said James Tracy, director of investment advisory services at New York-based Citigroup Inc.’s Global Wealth Management division.

Mr. Tracy, who represents the wirehouse end of the industry, where separate accounts have be-come a major part of the transition away from commissions and toward fee-based advisory models, attributed some of the separate-account slowdown to “platformization.”

“The emerging UMA platforms are competing with traditional separate accounts,” he said. “In the past, it was all active management, and now you’re seeing a blending of active management through separate accounts and passive management through mutual funds and ETFs.”

The UMA, Mr. Tracy believes, will have the effect of introducing more mutual fund investors to separate accounts.

“As clients become more sophisticated and aware of the unified managed account, they will become more involved and will want the open-architecture model,” he said. “I do think it will be an investor-led surge for separate accounts.”

Email Jeff Benjamin at [email protected].