Are Managed Accounts Obsolete?

This post is a summary from a session at the Financial Research Associates 9th Annual Managed Accounts Summit in Boston, MA.

These are three of the most frequently asked questions regarding the managed solutions industry according to David Gardner, Principal, Smart Consulting Firm, LLC.

Are managed accounts obsolete?

David informed us that managed solutions today are far from dead and are, in fact, alive and well. But we shouldn’t lump all advisory solutions together, he warned. As reported by Dover Research in the most recent edition of MMI Central (see the table below), Managed solutions reached $2.3 trillion in total AUM as of 2Q 2011. This was a 3.1% increase from 1Q 2011 and a 31.8% increase from 4Q 2010.

Clients are no longer seeking products, but solutions, David advised. They want greater rationalization, efficiencies of holding disparate assets, styles and strategies on a single platform.

Will the UMA kill off the SMA?

SMAs are far from dead, David continued. Third party, actively managed investment strategies provided by professional managers in fee-based accounts are still a viable part of our industry, he insisted.

Third party managed accounts for both sponsors and investment managers had trouble achieving operational scale when they maintained duplicate infrastructures that lacked standardization, according to David. The advent of UMA model portfolio programs provided efficiencies in areas such as investor profiles, account maintenance, custody, and trade execution, which helped firms deal with operating margins that have been declining over the past two decades, he said.

As of 2Q 2011, the SMA market showed a respectable growth rate, relative to the broader equity markets, growing by 2%, with $6 billion in net new flows, which is a positive indicator given the current market environment, David acknowledged.

From 2008 AUM until 2Q 2011 assets have grown steadily in SMA Advisory. During this period, as reported by Dover Research, SMA assets grew from $476 billion to $596 billion, which is a 25% increase. The growth of SMA assets has been in a steady decline since their peak in 2003. UMA market segment grew the fastest (7.7%) of all segments in the last quarter. It was largely attributable to newly launched programs, David said. SMAs aren’t going away, he assured us, they just have found a new home. They’re relocating onto UMA platforms with a lot of new friends living in the sleeves next door such as ETF, mutual funds, fixed income, multi-currency and alternatives.

It’s not SMAs vs UMAs, David argued, since SMAs have always been an available component of a UMA.

Are UMA model portfolios just a way to marginalize manager intellectual capital and compress their fees?

David’s point of view is that managers shouldn’t look at model portfolios in a negative light, they should look at them as a way to unburden themselves from maintaining a duplicate client account infrastructure. Model portfolios, he added, allow managers to do what they do best, which is managing money.

David pointed out that this is an age-old efficiency question with SMAs. As a manager, would you rather compete for a piece of a slower growth pie of SMA Advisory, and accept ever declining margins, or focus on the UMA model portfolio market, which is growing exponentially, although with lower, yet very stable fees, but with less overhead cost?

DTCC projects that the number of models being distributed will grow from 1,100 today to over 13,000 by 2015, David reported.  They also project in the same timeframe that half of SMA assets will convert over to UMA platforms.  They’re seeing announcements every day as more sponsors commit to wholesale conversions of their existing SMA relationships into UMA model portfolios, David confirmed.

David summarized by saying that UMA model portfolios allow managers infinite scale and efficiency to deliver not only their intellectual capital but also new products with increased profit margins and increased operational efficiencies.

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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.