Mutual Funds' SMA Foray a Long Road
October 6, 2003
Mutual fund companies trying to make a name for themselves in separately managed accounts are finding out that it is not for the feint of heart.
In the last few years, a number of traditional fund companies have observed the amount of cash being put to work in SMAs and decided to follow the money trail. The most obvious reason this move made sense for these firms was that it provided another way for them to market their existing portfolio management expertise, according to Matt Schott, a senior analyst at Needham, Mass.-based TowerGroup Research. Another reason, one that many firms wouldn't like to admit, is more of a defensive measure in that they wanted to ensure that customers didn't look to park their money elsewhere as the SMA product has grown in popularity.
The question that these firms had to ask themselves when drawing up their gameplan was, "Do we buy or build?" Some fund shops, such as Alliance, Eaton Vance and OppenheimerFunds, moved into the managed account space through acquisitions. Others, like MFS, AIM Investments and Putnam, have built their businesses from within.
No matter what tack a fund company decides to take, building a viable managed account business presents a number of significant challenges. For one, mutual funds are prohibited from putting more than 5% of their total assets in a single security. A large majority of firms could have upwards of 100 securities in an individual portfolio. "It probably doesn't make sense to own that many stocks in the managed account world," Schott said. That raises the question of how to narrow the scope of the portfolio to a more manageable number of securities.
Another tough decision to make is whether a firm wants to clone one of its more successful retail mutual funds. But an investment firm may not want the marketplace to discover it's offering nearly identical products in both channels, Schott said. Yet another problem he alluded to is whether a firm would want the same manager managing both products, since each has its own unique characteristics.
Meanwhile, there are a lot of mutual funds that sell direct to clients, so in order for them to get into the SMA business, they would be faced with the challenge of establishing a wholesaling infrastructure to work with the broker/dealer community. Simply getting shelf space with a sponsor firm could be a daunting task.
Another point to consider is that the nature of the product itself creates a challenge in that since it is distributed through a sponsor, or broker/dealer, portfolio managers lose a little bit of control over pricing. This puts their own compensation, the basis points they earn for managing an account, under pressure. So, profitability becomes a major concern there.
In For the Long Haul
"Traditional wholesale-distributed fund shops are better positioned to get into the managed account business than those funds that sell direct to the client," said Michael Evans, a vice president and consultant at Financial Research Corp. in Boston. He believes that it takes time to develop relationships, even for firms that already employ a broker-sold strategy. "In the separate account world, the sales process is significantly longer, he said. "It's not something you're going to be able to do in six months to a year and expect to raise a lot of money.
"If a [fund] company is committed to [SMAs] for the long-term, then it can definitely compete with some of the more established players," Evans continued. He cited MFS as an example of a mutual fund company that has done an excellent job of making a name for itself in the SMA space, garnering nearly $4 billion in three years.
"The single most important thing for a successful entree into managed accounts is commitment from the top," said Mark McMeans, president of AIM Private Asset Management of AIM Investments of Houston. "There are so many differences between managed accounts and mutual funds that you can't have a half-hearted offering. It just wouldn't work without [that commitment]. It's a very long, grind-it-out type process. The top of the house has to get that upfront, he said.
AIM first eyed the SMA business in 1997, but decided not to pursue it. At the time, the firm was enjoying substantial growth in its mutual fund business and determined that it would be taking its eye off the ball by getting into something other than mutual funds. Eventually, it could no longer ignore reports from the front lines that advisers were gravitating their business upstream and using managed accounts.