SMAs That Act Like Alternatives

This post is a summary of a session from the FRA’s 8th Annual Managed Accounts Summit.

While many money managers have been switching client assets into alternatives in their search for better returns, David M. Spungen, Chief Executive Officer of Hillview Capital Advisors, LLC, believes this is a bad idea. For a taxable individual, alternative investments, particularly hedge funds are extremely tax inefficient. They’re also expensive in terms of fee structures versus separately managed accounts.

According to David, Hillview does their own research and tries to locate managers that operate like alternative investments. They must be in separate accounts, with generally very workable minimums and reasonable, flat fees.

For example, Winward Investments (which was purchased in August 2010 by Charles Schwab for $150mm) has been successful in attracting assets from individuals, RIAs and large institutions, David revealed. When Hillview found them back in 2003 they were managing only $200mm.  By the time they were acquired their AUM was $3.9 billion.

What Winward has done is similar to what most fund of hedge funds are pitching, David said. Good risk adjusted returns, with much less volatility, and less exposure to a significant decline in equity markets. They have daily liquidity, a fair amount of tax efficiency, flat fees and total transparency. Winward runs essentially a global, multi-asset class strategy. They were also one of the early adopters of ETFs, which, David suggested, is one of the reasons that Schwab bought them.  (for more info, click here to read an interview with Stephen Cucchiaro, President, Windward Investment Management)

In 2008, Hillview started using a strategy that invests in both fixed income and closed-end funds on a hedge basis. It’s very tax-efficient since the fixed income side is invested munis.

David explained another reason for their tax-efficiency. If closed-end funds go to significant discounts to NAV, a lot of them overpay their dividends. They may go to a managed distribution policy and decide to pay 7% a year, for example. Hillview may earn 3% in dividends and another 2% in realized capital gains, which is basically just returned capital. So a lot of the return they get winds up being returned capital, which is very tax efficient, he explained.

Delivering Tax Efficient Investment Solutions

This post is a summary of a session from the FRA’s 8th Annual Managed Accounts Summit. The speaker for this session was Randy Bullard, Executive VP, Institutional Business Development, Placemark Investments.

Randy began by listing the three main areas where tax efficiency can be achieved:

  • Asset Placement – trust & estate planning, asset allocation and income management
  • Tax Efficient Products – low turnover strategies, passive products, insurance products, tax-deferred accounts, utilizing products that are tuned to different registrations.
  • Portfolio Customization – gain/loss matching, risk/tax trade-off management via portfolio optimization.

The goal of the tax management process is to match pre-tax returns and improve after-tax returns, Randy explained. Placemark does this with a quantitative, optimization-based overlay management process.

Since it’s ultimately the client that must pay the taxes on their accounts, managers should assess the tax alpha that can be derived based on a client’s circumstances to improve their after-tax return, Randy said.

“Managers don’t pay taxes, clients pay taxes,” he noted.  However, Randy pointed out that it’s impossible for an individual manager to meet a collective tax objective when managing their little slice of a client’s portfolio. That’s why a competent overlay portfolio manager is a critical component of of a tax efficient solution.

We may be in a moderate return environment for a while and if the Bush Era tax cuts are allowed to expire, the gap between short- and long-term gains rates is going to increase. That means the value-add opportunity for a tax optimization process also increases, Randy noted. Every time that delta between capital gain rates and income rates grows the value add opportunity goes up quite a bit.

How Break-Away Brokers are Changing the SMA Playing Field

This post is a summary of a session from the FRA’s 8th Annual Managed Accounts Summit.The moderator for this session was Kathleen Shkuda, President, Zigzag Consulting. The panelists were Eric M. Sutherland, Managing Director, Allianz Global Investors and Heather Gardner, Principal, CIMA, National Accounts Director, William Blair & Company.

According to Cerulli, separate account consulting has declined as a percentage of managed assets since 2007 while Rep as PM and Rep as Advisor have increased. This trend is projected to continue through 2011. One reason behind this is that RPM/RAA offer more control, Kathleen explained. With the onset of ETFs making it easier for advisors to manage portfolios, we’ve seen an increase in these two areas, she noted.

Kathleen reported that UMAs are growing, primarily at the big wirehouses. For example, Merrill Lynch is converting all of its separate accounts to UMAs and model portfolios. Even at some of the smaller firms, such as Bank of Hawaii (see below), MetLife & Citizen’s Bank are all starting their own UMA programs.

Independents have improved their recruiting and back offices and they have benefited from technology provided by custodial firms, Kathleen noted.

Wirehouses, on the other hand, have significant technology baggage. On the TAMP/ Custodian/ Independent side, they don’t have the technology backlog since they use outsourced solutions and truly open architecture, which gives them more flexibility. This allows an independent advisor or RIA to use more than one back office and get the best of all worlds.

From a money management standpoint, is there a preference for doing business with a wirehouse versus an independent?

“There is no preference,” Heather stated. “We want to be on both sides, because the advisors have been shifting both ways. In 2008/2009 the media was all over the big wirehouses losing advisors going independent.” However, Investment News has a trend tracker of advisor movement which showed that a lot of the wirehouse guys just went to other wirehouses. “We have to follow them,” Heather conceded. “You can’t let your advisor down if you have the assets there already.” As a money manager, William Blair has had to look at the economics from an SMA perspective. The firm would walk away from business if an advisor moved to another platform, but only had a handful of accounts.

Eric agreed, but believes it has to be a different model and approach, which is why Allianz is decentralized in the field. With wirehouses, they seem to have more success when they start with the home office and they have the research and the scale and the platforms in place, Eric explained. The downside of wirehouses is the economics. The rates continue to come down. “When we first got in this business, we were getting 65-70 bps, but those days are long gone,” Eric lamented.

How do you meet the needs of independents versus wirehouses?

On the independent side, Allianz has had better luck with newer strategies and carve-out strategies, Eric reported. Compared to wirehouse, the barriers aren’t the same, he said. Traditionally, you needed a 3-5 year track record and X amount of dollars in AUM. But now, a lot of wirehouses are building “emerging manager” categories, which allows newer strategies to get on their platform.

The two mindsets are very different, Heather observed. The independent side is very disjointed. From an SMA perspective, they’ll be used more by the larger teams for institutional or UHNW clients. “I think that UMAs will encompass a lot of the SMA business going forward as it becomes more adopted on the wire side,” Heather predicted.