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A Vanilla SMA That's Anything but Plain


Until now, the low-end separately managed account marketplace has seemed a bit like a Baskin-Robbins shop where you could get everything but vanilla. But if Kevin Carter has his way, the SMA industry could soon be getting a long-awaited 32nd flavor: index funds.

Carter, founder of Active Index Advisors, is betting that his plain-vanilla stock index funds with $100,000 minimums will have the same place among separate accounts as they do at the high-end of the investment world. He notes that while 40% of institutional money is in indexes, and 10% of mutual funds, only 1% of separate account dollars are in an indexed product.

In spite of its size (only six employees), the tiny San Francisco startup has big aspirations. "Our goal setting out was to be the Vanguard of the managed account market," Carter said.

That might sound like typical startup bluster, but Carter counts among his fans a name that's sure to make some investors and advisers take notice: Burton Malkiel. A proponent, and in some sense even a prophet, of index investing, Malkiel serves on the advisory board of Active Index Advisors. The author of the influential 1973 investment best-seller A Random Walk Down Wall Street, Malkiel has been a proponent of index investing even before there were index funds.

The Princeton University economist said he got involved with Carter's group because "it's got indexing, it's got low expense, it's got the tailoring to individual needs. That's why I'm actually very excited about it."

For Malkiel, Active Index represents a kind of next-generation form of index investment, one that's better for tax management purposes than either mutual funds or exchange-traded funds, he said.

Founded in 2002, Active Index Advisors opened for business last spring. Two Wachovia advisers who have used Active Index products since early 2003 include Adam Ezrilov and Mike Isola, who run a $150 million practice in Chestnut Creek, Calif. Ezrilov said that he likes the way passive indexing helps keep Active's managers focused on tax management.

Although indexing is not new to the SMA world - $6 billion Parametric Portfolio Associates, the Seattle-based division of Eaton Vance, has offered index-driven SMAs since 1997 - the Active Index offering differs from more established players in ways that reflect Carter's broad-market aspirations.

Carter believes he has the only SMA index fund he knows about that licenses the S&P name, which he says should be helpful to brokers and advisers in their marketing. The products are based on six of the most popular S&P indexes, including the S&P 500, the S&P 1500, and the S&P ADR/International Index.

But it's the $100,000 minimum account size that advisers who use the product cite as the biggest advantage. At Parametric, for example, marketing manager Far Salimian said that the $250,000 minimum the firm requires is largely a reflection of the large number of names in the indexes.

Carter's team got around this limitation through the use of technology to reduce the numbers of stocks needed to replicate the index. The proprietary technique Active Index uses tracks the index with up to 99% accuracy, according to Carter. Malkiel said the sampling technique Active Index uses is sound. "It's not rocket science but it's not just an easy slam-dunk, either," he said.

Of course, by lowering the minimum account size to $100,000, Carter has broadened his potential market substantially. One recent Cerulli Associates report cited by Carter pegs the average wirehouse separately managed account at $179,075 and the average independent broker/dealer account at $168,851. At the same time, however, he's kept pricing at an institutional level - about 40 basis points at the minimum, with some discounts further up.

The lower minimum has been popular with Ezrilov's clients, giving them a convenient way to implement a "core and explore" strategy.

Dot-Com Days

Carter is a recidivist investment-technology entrepreneur. He sold his last company, eInvesting, to E-Trade in July 2000. eInvesting was a system roughly analogous to FolioFN, according to Carter. The product was intended to enable investors to own a small but diversified portfolio directly, without going through a mutual fund. He says he got his current idea in part from his experience with that company.

This time around, he designed a product that fit in with the 30-50 stock size sponsors favor, with a management team and technology that can handle the stock-management chores that advisers didn't want to do.

The next order of business for Active Index is getting more investors in the door. Carter is looking for an A-round of financing. Until now, the company has grown entirely with about $1 million in funds of his own and his partners.

More information is available at the firm's Web site: www.activeindexing.com.

Bennett Voyles is a contributor to SMA Adviser, an e-mail news service from sister publication Financial Planning.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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