SMAs to Answer Trillion-Dollar Question
October 27, 2003
NEW YORK - Despite enjoying exceptional growth over the past five years, the separately managed account industry is now at a crossroads. The fragmentation of its infrastructure and growing operational challenges pose a significant hurdle for both sponsors and managers. Determining the best path for integrating operations with sales and marketing and how to improve the sponsor-manager relationship have many folks scratching their heads.
Members of the SMA industry met earlier this month to discuss these issues at the Money Management Institute's 2003 fall conference. "The separately managed account will no longer be perceived as a pricey alternative or consultative process," said Peter Muratore, chairman of the MMI. However, he cautioned that there are some "thorny issues," such as lower fees threatening profit margins and the lack of industry standards.
"We're at an inflection point for our industry," said Henry Kaplan, managing director of Morgan Stanley's Consulting Services Group. He noted that the mutual fund industry, which currently has about $7 trillion in assets, was at a similar crossroads in the late 1970's to the early 1980's. But if SMAs overcome operational difficulties, they could grow to $1 trillion - and eventually rival the mutual fund industry's $7 trillion in assets, Kaplan said.
SMA assets have grown from $161.01 billion at the end of 1996, to $442.86 billion this past June, and are expected to grow to $2.1 trillion of assets by 2011. However, one conference attendee told Money Management Executive the industry won't even reach a half a billion dollars unless these operational gaps are repaired.
Unlike a mutual fund, which is essentially one large account, and institutional platforms, which can have up to 25 accounts, the managed account is comprised of up to 1,000 individual accounts. "Supporting multiple platforms is an extremely high fixed cost," Kaplan said. Further, each investor has an average of 21/2 relationships, and the movement of information through various players is non-existent, causing a highly fragmented infrastructure, he explained. In particular, straight-through processing (STP) of information between money managers and sponsors doesn't occur because there is no standard platform, but MMI has held initial discussions about providing a standard means for trading and creating new accounts. Ultimately, the industry plans to develop a data format and a minimum standard for passing position, transaction information and performance data from the sponsor to the manager firm.
Outsourcing Game Plans
One way to address the problem of thin profit margins is to outsource operations to a third-party provider. When considering an outsourcing solution, it's important to know one's own strengths and limitations, said Walter Makarucha, vice president of The Bank of New York. Managers spend between $1 million to $3 million a year on in-house operations, he said. Since most managers need to reach $2 billion in assets to achieve profitability, outsourcing is a great way to alleviate that pressure on profit margins.
The added distribution support from an outsourcing partnership enables managers to access multiple sponsor programs, leverage existing technology and achieve scale, said Robert McCormick, first vice president of Mellon Financial. Mellon works with 30 sponsor firms and has six $10 billion clients. He said that it costs roughly 12 to 15 basis points to support operations and that outsourcing has enabled his firm to save two to three basis points. "You have to be technology agnostic," McCormick said. In other words, Mellon works with a wide range of platform vendors, and uses the best solution for a given situation, not one that they've standardized.
Meg Kelleher, senior vice president of State Street Global Advisors, said that when determining an outsourcing game plan, it is important to remain committed for the long term, and to align the goals of the firm with that of the outsourcing partner. That is at the very core of State Street's relationship with DST Systems, Kelleher said. She also observed that a wide range of firms are seeking outsourcing solutions, but that mid-size firms were the most active on that front.
Meanwhile, another hot button at the MMI conference was the development of new products and multiple-style portfolios, to appeal to a broader clientele.
Hedge funds, which are predominantly institutional investments, have grown 26% since 1990. "We are firm believers in following the money," said Jamie Waller, vice president of strategic marketing and business development at CheckFree Investment Services. But hedge funds present a problem in that they typically don't like people to see their short positions. In an SMA platform, the manager needs to be able to see all the positions within the individual account. Separately, hedge funds often don't have valuations prepared until several days after a transaction has been made, another sure problem, Waller said.
"Multiple-style, multiple-discipline portfolios, are the best thing for the client going forward," said Allen Williamson, group president at Nuveen Investments. An MSP could enable the adviser to offer such instruments as ETFs and REITS.
Expanding products also means that the industry needs to get a handle on best execution of trades. Currently, many firms use a trade rotation system that cycles trades through various sponsor firms. This is an area of concern for managers because it is possible that the end client may not be receiving best execution.
Given the current regulatory landscape in the financial services industry, it is an issue that needs to be addressed. Rick Austin, senior vice president at UBS Financial Services, said firms should have a written policy in place for trade rotation. To wit, it is likely that comparing prices for best execution and having written policies on trading away will become a best practice for the industry.
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