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Few Actually Use SMA Customization


While customization remains one of the key selling points for increasingly popular separately managed accounts, the usage of this feature remains low due to technology issues, complacency of certain providers and level of investor need.

One of the biggest draws about separate accounts is their ability to tailor the treatment of investment results to fit the needs of individual high-net-worth clients. Factors such as the investor's tax, retirement and risk management situations can all be taken into account. Customization can also allow investors to allow for social restrictions, such as avoiding "sin" stocks in their portfolio. Investors generally choose customization in order to create liquidity, hedge or diversify positions, or to transfer wealth. Risk, return and taxes can all be tailored to the individual's preferences.

However, the number of investors in SMAs actually

customizing their accounts remains fairly low. Chris Davis, the executive director of Washington industry trade group the Money Management Institute, citing preliminary results from a recent MMI survey, said only between 5% and 25% of investors have an active customization feature that is being applied to their account. However, he expects that number to increase going forward. "It's a feature that will grow in use as a portfolio grows in size and the client's needs also grow," Davis said.

Like SUVs

Customization is not needed all the time by all investors, Davis said. He likened customization in a SMA to the four-wheel drive feature on sports utility vehicles. Most of the time, drivers are navigating paved roads and there's not a need for four-wheel drive, Davis said. However, on the occasions one takes the vehicle off-road, it's a pretty important feature. "You don't use it all the time, but when you do, you are pretty glad you have it because you really need it," Davis said.

In a study released last year, research and consulting firm Cerulli Associates of Boston estimated that a mere 15% of all separate accounts, both taxable and qualified, are proactively customized, where the client requests certain securities not be included in the portfolio. However, up to 30% of all taxable separate accounts receive special tax treatment. These tax requests involve the client working with the rep to ensure the manager realizes certain gains or losses to offset other gains or losses in the account or portfolio.

Nonetheless, Cerulli predicts separate account customization requests will increase due to a combination of factors, including ramped-up marketing efforts by the consultant program industry to promote customization and the tax efficiency of the product. Additionally, a general increased awareness of issues relating to taxes for the product by affluent investors, sponsors and financial advisers, will help spur increased customization requests, Cerulli said.

SMAs promise customization, but in many cases fail to provide it, especially when marketing employees get involved with the promotion of the product, according to David Stein, managing director and chief investment officer of Parametric Portfolio Associates in Seattle. Parametric is an investment firm specializing in tax-efficient equity portfolios. Firms with large marketing organizations often promise customization to clients, who are unaware that the feature is not completely available yet because certain processes are not in place, he says.

Not Cheap'

"The reason it's not being done more is it's complex and not cheap to do," Stein said. Because of the amount of detail and complexity involved, expenses may increase, which is often only justifiable at the higher asset levels, he said. Those at the lower end of the SMA scale basically receive the same portfolio management as they would in a mutual fund. "There are people who want to feel they are being treated differently," even if that is not the case, he said.

However, many asset managers are working on customization and it is evolving, but there are those in the industry who are simply not interested in bringing this feature to their customers. Stein said that some firms are already selling the product and see no need to be bothered with the processes needed to bring certain forms of customization.

Len Reinhart, president of separate account services at The Bank of New York, New York, characterized separate accounts as a "customizable mutual fund for a client," noting that some firms sell the product as they would a mutual fund. "It varies from firm to firm in how it's sold," Reinhart said.

The level of automation and the type of technology used are key in offering customization, he added.

Ron Surz, who runs PPCA, a San Clemente, Calif., technology firm that sells to financial intermediaries, said as a practical matter, firms can't customize every portfolio. He said most SMA products are "cookie cutters" and are "prepackaged." Firms have a set number of prototypes that generally fit with SMA investors' needs from which they can choose, he said.

Surz also pointed to technology as one of the shortcomings holding back customization. "Most of the technology they are using is from the 1980s," he said of many SMA programs. "I don't think the tools these guys are using are as good as they can be."

Copyright 2003 Thomson Media Inc. All Rights Reserved.

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