The Future of Advice Delivery: What Will Solutions Look Like?

This is a summary of a session from the FRA’s 11th Annual Managed Account and UMA Summit that was held in September 2013 in NYC.

Moderator: Walter Hartford, VP, Business Development, F-Squared Investments


Unified Managed Accounts (UMA’s) are not a silver bullet

What the managed accounts industry needs is new investment options, not new account types, Shkuda contented.  UMA’s are not a silver bullet that can solve all of a client’s investment needs.  What’s inside an account is more important than the account structure, she claimed.

Shkuda proposed that UMA growth has been flat for the past few years because the strategies being offered aren’t providing solutions for what clients perceive to be their needs.  Managed account providers must improve on their track record of innovation in order to increase market share, she suggested.

The following three rules were offered by Shkuda for the industry to be more innovative:

1) What has worked in the past, won’t work in the future – mainly due to increasing levels of competition
2) Firms must continually re-invent themselves – especially larger sponsors and wirehouses who are often afraid of cannibalizing their existing business
3) Think outside the box Continue reading

Asset Allocation: Is Modern Portfolio Theory Dead? (1/2)

This is a summary of a session of the Money Management Institute’s 2012 Fall Solution Conference.

Michael Jones, Chairman and Chief Investment Officer, Riverfront Investment Group
Colin Moore, Chief Investment Officer, Columbia Management, $339 billion AUM
Howard Present, President and Chief Executive Officer, F-Squared Investments
Steve Murray, Director of Asset Allocation Strategies, Russell Investment Group

This was an interesting discussion since each of the panelists approach asset allocation from a different perspective.  Jones believes that modern portfolio theory (MPT) is dead and that asset allocation should be more fluid and dynamic so they shift the pie chart around.  Riverfront has a simple methodology, which states that the price you pay is the number one determinate of the upside potential and downside risk of an investment.  They feed the price into a proprietary optimization process to create a portfolio that tries to make money in a worst case scenario while still maximizing the upside potential.

Moore agrees that the standard process is deeply flawed and feels you shouldn’t maximize return for a given level of risk.  Instead you should figure out what is the maximum level of return that the client can accept.

F-Squared believes that downside risk management has a disproportionate impact on clients, according to Present, so they factor it into their portfolios at a higher level.  Standard deviation is used to represent investment risk and maximum drawdown to represent the client’s perception of portfolio risk, he said.

Murray disagrees with Jones and believes there is some value in modern portfolio theory but that it is just one data point.  It’s not enough to rely on by itself.  At Russell, they know that different asset classes follow different pattens in the market so they use using different asset classes to offset each other in a portfolio by combining long and short term market processes, he stressed. Continue reading

Fee-Based Advisors Clamoring for Muni Bond Ladders

Are fee-based advisors looking to move more managed account assets into municipal bonds?  There is evidence that this is the case and that muni bonds as a percentage of managed account assets could grow over the next few years.

Research from MMI/Dover shows consistent growth of fixed-income SMA objectives that corresponds to a consistent decline in domestic equity objectives. In mid-2010, domestic equity held a scant lead, 40% to 37%. Among model portfolios, taxable fixed income leads the list with 22.4% of assets, ahead of large-cap value (19.1%) and large-cap growth (17.8%).

Some of the broad investment trends that have surfaced in recent years–alternative investments and tactical asset allocation–can be found in managed accounts.  Jean Sullivan, from Dover Research, says that these programs generally have become more conservative, with an increase in fixed-income strategies.

While taxable fixed-income SMAs are the leaders, municipal fixed income doesn’t even make the top 10, holding less than 2% of portfolio assets. “Many investors in fixed-income SMAs are nontaxable, such as 401(k)s and pension plans,” says  “They hold taxable bonds, Treasuries, agencies, corporates and some asset-backed securities.”

Why would investors want to hold bonds via managed accounts instead of a bond mutual fund or a low-cost ETF that tracks a bond index? Financial Planning Magazine quotes Randy Dry, managing director of the institutional group at Thornburg Investment Management in Santa Fe, N.M.:

“For the same reasons that you’d use separate accounts for equities,” Dry responds. “Investors own the underlying securities, not shares in a fund. You can make trades that improve your tax position. And you avoid the ‘flow shock’ that may affect mutual funds.”

Dry explains that investors get bond ladders with his firm’s fixed-income SMAs. About one-tenth of the portfolio matures every year and the proceeds are reinvested in 10-year bonds. This strategy, which some other fixed-income SMAs also follow, can protect long-term bond investors against rising interest rates because money would be available for reinvestment at the higher rates.

Thornburg, which offers muni bond SMAs, has a $2 million minimum. With smaller amounts, investors may have less diversification and face wider spreads on trades, Dry says.

One of my previous blog postings, Current Challenges for UMA Sponsors, covered a session from the MMI 2011 Spring Convention. Representatives from both UBS and Merrill Lynch both reported that their advisors had requested the ability to provide muni bond ladders to their managed account clients.  However, there are issues that have blocked these offerings being made available, such as determining the proper minimum account size and the amount of alpha that muni managers can bring.

While UBS and Merrill are still considering bond ladders, other large sponsors have moved ahead to make them available on their managed account platforms.

For example, in March 2010, Schwab Managed Account Services™ partnered with PIMCO and launched a bond ladder offering called the PIMCO Municipal Bond Ladder Separately Managed Accounts—five professionally managed strategies that seek to generate income by leveraging investment opportunities in the municipal bond market.

According to Schwab:

PIMCO conducts continual credit surveillance, reinvests maturing securities, and provides institutional purchasing power, all for a highly competitive fee. The SMAs have an investment minimum of $250,000 and a program management fee of 0.35% for the first $1 million invested, 0.30% for the next $4 million and 0.25% for investments above $5 million.

PIMCO selects investment-grade municipal bonds with an average credit quality rating of A- or better at purchase. These are assembled in laddered portfolios with 1- to 6-year, 1- to 12-year, or 1- to 18-year maturity rungs.

Some of the benefits of adding a muni bond strategy to a managed account include:

  • Periodic income generation—The strategies seek to generate tax-efficient, periodic interest payments, which can be distributed as they accrue1 or reinvested into new bonds in the ladder. Of course, investing in bonds carries risks, including the risk that a bond may fail to pay interest or principal, and the risk that it may lose value.
  • Ongoing credit monitoring—The manager selects investment-grade municipal bonds and regularly monitors the credit quality of your account holdings.
  • Bond replacement—When a bond matures, the manager will reinvest the principal by purchasing a new bond, typically at the longest maturity range or “rung” of the ladder. The ladder is extended until you request a payout of principal or your account balance falls below the $250,000 minimum.
  • Direct ownership and transparency—Unlike fixed income mutual funds, a municipal bond ladder offers direct ownership of the underlying bonds.

LPL Financial also claims that their proprietary fixed income trading platform that allows financial advisors to build bond ladders, select products, and process trades online for municipal bonds, corporate bonds, new issue corporate notes, and FDIC-insured CDs.

An article from, Trends in Separately Managed Accounts: UMAs, ETFs and Alternatives, confirms that Envestnet is also seeing an uptick in requests for bond ladders.  The article quotes Mike Henkel, managing director of Envestnet/PMC and Tom Simutis, an Envestnet/PMC senior VP in charge of relations with SMA managers:

Fixed income alternatives are of particular interest to advisors now—“no one wants to be on the long side of fixed income,” says Henkel. Simutis confirms that Envestnet/PMC is always getting requests for strategies that are “noncorrelated” to the broader stock indexes, but also “replacements for fixed income. SMA managers are using ETFs, they can use synthetic shorts, can buy bundles of equities.”  There’s a growing use of ETFs as a component of a SMA manager’s strategy, he says, “where the rest of the portfolio may be invested in stocks or bonds.”

What else are advisors looking for? Simutis says that on the fixed income side, in addition to alternatives “it almost seems like a move toward a more traditional approach; we’re getting a lot of calls” for bond ladders, because “they’re cheap and easily understood.”

While this evidence is far from conclusive, it does appear to be a trend that should be monitored.  It would advisable for sponsors to investigate offering muni bond strategies on their platforms, so that they will be ready to respond when their advisors start demanding it.

JPMorgan Doubles Model SMA, UMA Business in 2010

FundFire has an interesting article about the tremendous growth of JP Morgan’s managed account programs last year.  The article, written by Tom Stabile, describes some of the key features that made JPM’s programs so successful.  It also points out some new trends that are appearing in the industry.

Open Architecture

Is their UMA open architecture or not?  Here’s what the article says:

JPMorgan is the exclusive provider of SMAs to the fast-growing Chase UMA program, which combines SMAs, mutual funds and exchange-traded funds in a single custodial account. The UMA has an open architecture platform for mutual funds and ETFs, with product selection from a Chase due diligence team.

Well, since no outside SMA managers are available, it’s not really open architecture.  But how important is this?  It had no measurable effect on their ability to gather assets last year.  Does this mean that open architecture isn’t important to clients?

Keeping SMA management in-house  is certainly more profitable.  Managers usually charge 30 bps for providing their models to a UMA.  JPM can pocket this to boost profits or use it to lower their overall fees and undercut their competitors.

Models Matter

I’ve been hearing a lot about how models-only is the wave of the future and assets in manager-traded SMAs are disappearing fast.  According to the article, JPM’s models-only programs added $1.6 bil in 2010 while their traditional SMA programs lost $0.4 bil.

The data underscores that models are an increasingly vital component for SMA manager business lines, says Jed Laskowitz, head of distribution for JPMorgan Funds Management, the retail arm that also runs the SMA business.

This same trend seems to be occurring around the industry.  Three managers alone – Allianz Global Investors, Neuberger Berman and Lord, Abbett & Co. – transitioned more than $20 billion in assets to the model portfolio format in 2010, according to a report by Cerulli Associates.

Last week I spoke to Mike Everett, head of Business Development at MyVest.  He said that he sees the market share of traditional SMA programs declining due to the increasing popularity of models-only.  This trend will negatively impact technology vendors that rely on manager connectivity as their primary selling point.  “In a models-only world, connectivity to managers doesn’t matter,” Mike noted.

The Most Interesting Part

This is the part where I’m quoted:

The Chase brokerage arm does appear to have an edge helping it outpace many competitors, says Craig Iskowitz, managing director of Ezra Group, a consultancy. One of those is being able to tap its asset management affiliate.

Another strength appears to be how Chase’s UMA already has a format many competitors are trying to establish – fully discretionary client relationships, which means advisors don’t have to check back with clients on every investment move, and a model that keeps most portfolio decision-making at the home office.

“It’s way more efficient to have it done in the home office,” Iskowitz says. “And if you have a good [investment] mix, it can be powerful because studies have shown that asset allocation is 80% of your return.” He says adding in a solid technology platform with robust rebalancing capabilities can greatly increase efficiencies for a brokerage operation.

I decided to fact-check myself and found that 80% is incorrect.  The most commonly cited research (this one and this one) report that asset allocation makes up more than 90% of a portfolio’s return.  Although, a recent article by Thomas M. Idzorek (published in Morningstar Advisor magazine) claims that “After removing the market movement, asset allocation and active management are equally important in explaining return variations.”

More Bad News for Bonds

Another instance of someone predicting that bonds will fall out of favor in 2011:

[Jed] Laskowitz says the SMA business overall may be set for a rebound this year, with signs that investors may tilt to equities.

I wrote about how some managers are predicting poor performance for bonds in a prior blog posting entitled, Why Bond Portfolios are a Flawed Retirement Strategy.  Laskowitz believes that investors will re-evaluate their portfolio risk and look to increase their weight in equities, which naturally leads to more interest in SMAs.

MFA – The 600 lb Gorilla

While UMA is still the pretty girl in the room, Mutual Fund Advisory (MFA) continues to suck up assets at every sponsor and JPM is no exception:

Most of their focus is on the mutual fund business, where JPMorgan enjoyed significant inflows of $20.7 billion last year, placing second industry-wide, behind only PIMCO’s $64.1 billion, in new assets into actively managed long-term mutual funds and ETFs, per data from Strategic Insight.

What I’d like to see is a detailed comparison of the JPM UMA/SMA programs versus some of their competitors to try and identify where they have advantages that could be the drivers of their AUM growth.

Why Bond Portfolios are a Flawed Retirement Strategy

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

There are three phases of life and three phases of investing based on a client’s income needs: Growth Only, Growth and Income and Income Only, according to Michael Jones, Founding Partner, Riverfront Investment Group. For retirees in the Income Only phase, what they really need is a cash flow that grows.

Instead, what the industry has done is use systematic withdrawals and build a growth portfolio with a little lower volatility and then hope that everything will work out, according to Michael. The financial crisis showed a major flaw in this strategy. Suddenly a 6% annual withdrawal became a 9% annual withdrawal due to the drop in valuation. If you’re blowing a hole in your portfolio on year one, it’s really hard to bounce back, he observed.

“What do retirees want?”, Michael asked.  They want a quarterly statement from their asset manager that has the same number on it as it did last quarter.  That’s how they define safety.  What do they need?  Income.

Because of this, Michael pointed out that retirees are scared and they’re running to bonds.  They didn’t want bonds back in 1990 when interest rates were at 9% or in 2000 when they were 7% or in 1984 when they were 14%.   Now we have 2 ½% treasuries and they can’t get enough of them!

According to an article Michael recently published (“The Bond Bubble: Are Your Portfolio’s “Safe” Assets Safe?”), he expects deflation will be avoided and “history suggests that bonds currently offer extremely low potential returns in exchange for a substantial risk of loss. For example, if 10-year Treasury yields rise to 4%, a level seen as recently as April 2010, bond investors are likely to incur a principal loss of approximately 10%.”

In this environment, if we don’t get inflation, bond investors will be hit hard. As Michael explained, while treasuries were overvalued, corporates, mortgages and high yield were so cheap you could get away with buying bonds and make out reasonably well because spreads were so wide. But now, spreads have collapsed and yields on all those asset classes are at all-time lows.

Compared to the returns on a one- year treasury rolled over annually, the dividend yield on the S&P 500 beats it handily over the past 40+ years. In the past 10 years, there’s been a 40% increase in dividend income from the S&P500, even with the financial crisis, Michael reported.

You can potentially get a higher yield from the dividends paid by the stocks in the S&P 500 than from their 10- year bonds. All the growth potential and net dividends you can get for free. More current income, more future income higher short-term volatility, but lower in the long-term.