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Planners' Grasp of SMAs Moves Forward

It takes society 30 years to become comfortable with a new technology - be it steel plows, electric lights or video recorders. The device doesn't matter. By that standard, financial advisers are doing pretty well with separately managed accounts.

Although separate accounts began growing in popularity just a half-dozen years ago, a number of financial advisers have already developed a deeper understanding of what SMAs are good for and how to manage them. With this understanding, some have the confidence to begin experimenting with them.

"I think most of the financial advisers who use separate accounts are still using them in pretty much the traditional way in which financial advisers use mutual funds. [This means] devising an asset allocation strategy among asset classes and styles - large, small, growth, value, etc. - and then hiring managers to fill those slots," said Scott MacKillop, a principal with Evergreen, Colo.-based Trivium Consulting.

New Strategies

But now, MacKillop said, he is also starting to see advisers experiment with new kinds of allocation strategies. The first, he said, is the controlling account concept, which is a strategy Lockwood's Len Reinhart has been trying to popularize. Under this strategy, all portfolio rebalancing, tax-loss harvesting and strategic allocation shifts are made in one part of the account, while the other sections of the portfolio are left alone. The idea, which MacKillop said is borrowed from the institutional investment world, is to simplify the management and coordination of the account.

A second strategy now being used in SMAs, MacKillop said, is called "core and satellite," or "core and explore." Here, he said, the idea is that because academic research has shown that the large equity market is very efficient, an active manager is statistically unlikely to be able to add much value. Instead, the planner builds a portfolio that tracks one of the indexes and then hires active managers for the less picked-over asset classes. Beyond the performance advantage of combining active and passive investment styles in one account, he said, this strategy can be useful in helping to avoid inefficient transactions-- such as having a growth manager sell a slow-performer at the same time a value manager is buying the same stock.

The difficulty with the "core and explore" idea, MacKillop said, is that most clients tend to be interested in either active or passive investment styles. "It's like trying to be Jewish and Catholic at the same time," he said.

Ultimately, these ideas may be seen as part of a larger effort to integrate the different parts of a separate account. The diversity of management is one of the strengths of the SMA model, but it can create problems as well, investment analysts said. Larry Sinsimer, senior vice president and managing director of managed accounts at Eaton Vance Distributors in Boston, described the movement toward better communication and control as part of a third generation of separately managed accounts. The first was an account managed by a single company. The second, an account managed by multiple firms and managers. This generation, he said, will be accounts managed by multiple firms but controlled by only one of them - a quarterback, essentially, he said, who can make sure that the different parts of the portfolio aren't working against each other.

Another key trend SMA watchers see is the use of the SMA as a supplement to mutual fund positions rather than as a substitute. "There are very many client accounts that I see here at AIM where both mutual funds and separately managed accounts are utilized," said Mark McMeans, president and COO of AIM Private Asset Management of Houston, which manages $1 billion in separate accounts.

In general, the larger the account, the more assets will be kept in the separately managed account rather than in mutual funds, McMeans said, but his sense is that many accounts combine the two. The reason: there are certain kinds of strategies, such as sector rotation and emerging-market investments, where mutual funds remain the better vehicle. Demand is not strong enough yet for money managers to justify a manager operating in some of these strategic niches, he said.

SMA planners have also been making large sector adjustments this year, as well. In particular, bond funds are now taking a bigger slice of the $443 billion SMA pie, according to Money Management Institute figures. The Washington-based managed account trade group found that taxable fixed income accounts have grown by 56%, followed by the 45% jump in large-cap value. Smaller winners included large-cap growth, which gained by 23%, taxable balanced funds, which also grew by 23%, and convertibles, which grew by 18%. The big losers were international equity, which declined by 14%, and large-cap core, which shrank 15%.

Brian T. Neale, an institutional analytics associate at Wachovia Securities, Richmond, Va., said many of his clients have favored fixed-income strategies this year. To enhance performance, he said that Wachovia has tried to put 10% to 30% of fixed-income assets into high-yield instruments and convertibles to improve the "income stream but at the same time reduce volatility."

Driven by Fear

A number of planners and investment managers report that SMA allocations are being affected by their clients' fears of the market. Even three years after the crash and despite this year's runup, many advisers report that their clients are still extremely cautious. "People are still somewhat gun-shy, to some extent," said Wade Evans, a financial planner based in Baton Rouge, La. Attitudes are different now, Evans said: "People want to be significantly more conservative today than they were in the '90s. Now they understand what risk is all about."

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