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SMAs Predicted to Accelerate to $2 Trillion By 2011

NEW YORK - The separately managed account (SMA) industry has been gaining momentum recently, but is about to accelerate to a major growth spurt in the next few years according a number of speakers at The Money Management Institute's 2003 annual meeting here earlier in the month.

SMAs will jump to 12.5 million accounts and balloon up to $2.1 trillion in assets by 2011, said T. Neil Bathon, president of Financial Research Corp. More immediately, FRC is surmising that the industry will swell to 5.3 million accounts and $930 billion in assets by 2006.

Many feel, or even fear, that the growth of the separately managed accounts industry will come at the direct expense of the $6 trillion mutual fund industry.

"There's going to be an erosion of fund assets," Charlie Bevis, vice president at FRC, said in an interview. "The $64,000 question for mutual fund companies is, How do I divide my efforts? How do I invest in the managed accounts business when there are some players already deeply entrenched in that area?," he said. There are tons and tons of issues and questions that the projected growth of SMAs should cause mutual fund executives to ask themselves. "And there aren't any easy answers," Bevis said.

Separately managed accounts have fared well as investors have looked to put money into a more personalized product. That industry has grown by about 33% since 1998, with assets checking in right around the $400 billion mark.

More precisely, figures released in February by the MMI, the national association for the managed account industry, indicate the industry grew to $398.7 billion in assets at the end of 2002. That total was a 4.4% increase from the $381.8 billion at the close of the third quarter, but a slight dip from the $399.7 billion at the end of 2001.

However, in comparison to the broader market, separately managed accounts have remained stable. This sharply contrasts with the activity in the overall investment market over the last year. The S&P 500 Index fell 22.1%, while the Russell 2000 Index sank by 20.5%, and foreign stocks, as represented by the MSCI Europe/Australia/Far East Index, lagged 15.9% in 2002.

At the conference, FRC said the SMA industry totaled 2.04 million accounts at the end of 2002. The figures, which are part of a study conducted by FRC in conjunction with MMI, indicate that SMA industry year-over-year net sales increased by 181% in 2002, totaling about $50 billion.

Continuing Demand'

"Projected growth in total SMA industry accounts offers an unmistakable measure of likely, continuing investor demand for this investment approach," said Christopher L. Davis, executive director of the MMI.

"The trend we foresee for the rest of this decade builds on the emergence of very strong investor interest in SMAs over the past five years," Davis continued. "Our asset base has proven remarkably steady even in the midst of extreme market turmoil, further indicating that our investors have embraced the SMA concept as an optimal long-term investment management approach."

Bathon's presentation pointed out what FRC believes are several distinct differences between mutual funds and SMAs, many of which may lead high-net-worth investors to choose SMAs over mutual funds.

Mutual funds have shared ownership and no customization, while SMAs have direct ownership and high customization. SMAs have robust reporting, while mutual funds possess standard reporting.

Additionally, mutual funds have a packaged sales process, while SMAs have a consultative process.

However, not all investors can afford SMAs, as they have a minimum investment of $150,000 per account, while mutual funds have a much more attainable $2,500 minimum investment. Bathon also pointed to the 1.9% to 2% cost to investors in SMAs, versus a 1.4% plus advice cost to mutual fund investors.

Not everyone is so sure SMAs will take the investing world by storm and steal any thunder from mutual funds. John Bogle, former chief exec of Vanguard, said it is not at all clear that SMAs have significant advantages over mutual funds. In a speech given last year, Bogle said that costs of SMAs are higher than those of mutual funds, that SMAs don't necessarily provide investment advantages and that the challenges of operating SMAs are substantial.

While a lot has changed in the mutual fund industry in the year since Bogle's speech, some fundamental beliefs remain the same. "Nevertheless, if mutual funds fail to change, our dominance will come to an end," Bogle said. "We hold no permanent monopoly on the good will of our owners. We must re-earn it every day."

Mid-Tier Fund Squeeze

FRC also recently released its third volume on the future of the mutual fund industry. The report claims that mid-tier fund companies, those with $10 billion to $75 billion in mutual fund assets, will be impacted the most by evolving distribution and product trends, forcing these firms to confront three basic strategic options - grow, shrink or consolidate

The study also reinforces the message put forth in the first two installments: The party is over for mutual funds as we know it today. The mutual fund industry will be recrafted by 2007 to reflect the broader investor and product perspective most fund companies will possess, FRC asserts.

FRC had previously released a report warning that mutual fund companies would face a dramatic change in clientele in the upcoming years, with an increased emphasis toward retail investors. That is because they are expected to lose wealthier investors' cash, which will coincide with a dramatic increase in separately managed accounts, the Boston-based firm said.

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