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AIMR SMA Standards Present Challenge

Much has been said about the growth of the separately managed account industry - both in terms of the growth this market segment has experienced in the past few years and also in terms of the anticipated growth that many analysts predict. Once distribution channels become optimized to handle the expected growth of SMA money, it is widely predicted that SMAs will replace mutual funds as the investment product of choice for individual investors.

At the same time, the separate account industry is facing a situation whose root causes can be found in the way the industry is structured and, ultimately, the lack of advances in the portfolio software used to manage separate accounts. The issue at hand is the ability of money managers to become compliant with the performance presentation standards (PPS) of the Association for Investment Management & Research (AIMR) of Charlottesville, Va.

As the separate account industry and its participants take steps to redefine this segment of the market to realize the growth potential that analysts are predicting, the shortcomings of the technology used by many firms must be addressed. The history of American separate accounts also serves as an educational case study for the developing wrap markets in Europe, Asia and the rest of the world.

In 2002, AIMR released a guidance statement on "wrap fee performance." Largely, the purpose of this guidance was to clarify the meaning of the text of the AIMR performance standards as they applied to wrap fees. However, the guidance also distilled the critical components of the standards that are meant to apply to separate accounts, both institutional and retail.

Of the issues covered in the guidance statement, the single statement that presents the largest impediment to manager compliance is the very first statement of the standards: "All data and information necessary to support a firm's performance presentation and to perform the required calculations must be captured and maintained."

Daily Valuations

The implication of this statement is that a money management firm that wants to be compliant with the standards must have a complete transaction and position history for the period of time covered by its performance presentation. Without the data to substantiate the returns presented, the presentation cannot be verified as compliant.

The current requirement for institutional or individual accounts is for monthly valuations of accounts. The standards include, however, a gradual increase in the accuracy of the posted rate of return data. Daily valuations will be required beginning Jan. 1, 2005. This increases the data burden on the management firm significantly; instead of monthly positions and daily transactions, the requirement becomes daily positions and daily transactions.

In order to fully understand the implications of these data requirements, we must look at the roles of the participants in the separate account industry: the individual investor the sponsor firm, which sells the managed account product to the individual investor; the money management firm, who is hired by the sponsor firm to make investment decisions; and the adviser or consultant, usually a representative of the sponsor firm that is the liaison with the investor.

The sponsor firm, in addition to hiring managers, administers the separate account program. This includes facilitating trading and settlement, client reporting and performance measurement, and providing the platform software used by the money managers that participate in their separate account program. As a result, the sponsor firm maintains the position and transaction information on its portfolio accounting software.

This presents a critical problem to money management firms; the software systems typically used by sponsor firms are older systems developed by the sponsor firm itself or by a third-party vendor that has not adapted its system to take advantage of newer technologies. Managers need the ability to easily extract account position and transaction information from the sponsor systems. The technologies that would enable this include relational databases, file extracts in easy to process formats (preferably XML - extensible markup language), plus intuitive Web-enabled user-interfaces that would enable money managers and advisers to extract the data without requiring the assistance of highly technical personnel. Because the systems utilized by most sponsors today do not employ these technologies, it is impossible for many sponsors to allow managers to extract data.

Additional Complications

There are additional complications to the situation. Sponsor firms currently provide performance reporting to the investors themselves, so the needs of the investor are met from the sponsor's viewpoint. There is little incentive for the sponsor to provide a data extract of positions and transactions for the manager. If they were to do so, they would assume an additional liability for its correctness.