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Few Take Full Advantage of Separate Accounts


In a recent advertisement, Lincoln Financial Group of Hartford, Conn., told financial planners, "Customized financial solutions. Just another way we make you look like the good guy." In fact, many separately managed account providers have begun to make separate accounts' customized features the cornerstone of their marketing efforts, according to Cerulli Associates of Boston.

However, it's not clear that investors are getting the message, as few are taking advantage of the customizable features for which they are paying.

In 2001, only 30% of all taxable separate accounts received specialized tax treatment, and only 15% of all separate accounts were proactively customized through security restriction requests, whereby a client requests that specific securities are not bought into the portfolio, according to Cerulli.

Separate account consultant program assets reached $319 billion at the end of 2001, a growth of 6.8%, according to Cerulli. By comparison, long-term mutual fund assets dropped 7.5% in the same period. If investors are not using the customized features of separate accounts, why are they paying the higher fees - typically around 2% - that are associated with them?

"You don't want to buy something that you're never going to use," said Kevin Keefe, vice president and senior analyst with Financial Research Corp. of Boston. "It's an expensive option. You certainly want to be comfortable that the customizable features of [a separately managed account] will be useful before buying it."

But just because most investors did not take advantage of the specialized tax treatment or security restriction option in their separate account in 2001 does not mean they did not consider it or won't take advantage of these features in the future, Keefe said. Actual usage is an important statistic, but perhaps an even more important one is how many investors evaluated their accounts at all, he said.

One of the reasons why investors may have underutilized the tax treatment flexibility in separate accounts in 2001 is that the vast majority of investors had no gains to offset, said Jack Rabun, an analyst at Cerulli. Considering last year's market environment, tax treatment activity was probably at a low, he said.

Also, usage of those features can be sporadic because their advantage is contingent on other parts of an investors' portfolio or even other events in an investor's life, said Robert Dineen, senior vice president at Merrill Lynch's Managed Solutions Group in New York. For example, if someone sells a house, he or she can utilize the customizable tax treatment to offset that taxable event, he said.

"I don't think [the usage] statistic is a really good one to hang our hat on because it's down the road," said Mark Pennington, director of private advisory services at Lord Abbett of Jersey City, N.J. "One year it might be 20%, the next year 60% and the next year 10%."

Pennington compared a separately managed account to an SUV. People do not buy SUVs to use the four-wheel drive capability all of the time, he said. The four-wheel drive capability is only needed at certain times. But people who will never have use for four-wheel drive buy SUVs as well, and they view separate accounts as a similar luxury item. According to one industry executive, one of the reasons managed accounts have become so popular is because of their "snob appeal," and many of those investors do not need or will not utilize the customizable features.

Although the number of separate account customization requests was low in 2001, Cerulli anticipates that will grow in the next few years. One of the reasons is that the industry is using customization and tax efficiency as the key messages in its marketing efforts. Separate account providers are pointing to those features and comparing the benefits to mutual funds when educating investors and making sales pitches to clients, Rabun said.

As investors, especially affluent investors, become better educated and more concerned about the impact of taxes on investment performance in general, account customization requests are likely to increase, according to Cerulli. Further, financial advisers are increasingly seeking out tax-awareness and customization capabilities.

While separately managed account providers are trying to sell clients on the advantages of customization, they do not necessarily want investors to utilize the option. Responding to those requests is work for the firms, and the more they have to do with each account, the greater the cost of servicing each of those requests.

"When you're dealing with accounts on an individual basis, [additional requests are] more costly, simply because of their nature. Your margins will go down," Rabun said. "The key is to find a way to offset that pressure."

One of the directions the industry is moving in is the implementation of technology solutions that will standardize account management, Rabun said. The industry is currently working on creating something similar to the common clearing platform of the National Securities Clearing Corp. of New York.