SMA Product Glut Leads to Fee Compression
April 19, 2004
The stranglehold on the distribution of separately managed accounts by a handful of wirehouses has again driven down fees paid to equity investment providers. Recently, Wells Fargo reportedly cut its SMA equity management fees to 36 basis points from 38 basis points, and experts believe that other national distributors are likely to follow suit.
Many asset managers have the size and liquidity to survive the downturn in fees, but experts worry that investment providers with limited portfolio capacities -- such as small-cap, mid-cap and international strategies -- could turn their backs on the SMA business and invest their limited resources in higher-profit investment vehicles. Mutual funds, institutional accounts and SMAs that invest in larger cap equities are three types of investment vehicles with higher profit margins.
Mike Bares, a spokesman for Wells Fargo, declined to comment, but experts note that the SMA industry is flooded with large-cap strategies, which are the most liquid, and in the shortest supply of small- and mid-cap and international portfolios. The latter three investment styles run the risk of illiquidity and extreme sensitivity to capacity constraint.
"If you have the opportunity to pursue the mutual fund business, which offers management fees between 75 and 100 basis points, versus the SMA business, which pays half of that, it's not a stretch to understand why firms are looking to other outlets," said Jack Rabun, a senior analyst at Cerulli Associates of Boston.
And with the separately managed account industry flush with options in the full range of investment style categories, distribution companies have little incentive to raise management fees. Investment providers have also put up limited resistance to the free fall in management fees that began in 2000 due to growing scrutiny from the media and securities regulators looking into mutual fund expenses, according to one fund company executive who requested to remain anonymous.
Although the total number of SMA strategies offered to financial representatives is steadily rising, some experts suspect that the growth is mainly tied to the number of asset management firms that can withstand the climate of withering fees. Asset managers that have made the investment to enter the SMA industry are simply expanding their number of offerings to appeal to sponsors, and in their effort to hold onto this business, do not seem to mind the downward pressure on fees.
But this glut in the market is not the right kind of glut. While private client groups looking for exclusive arrangements with boutique asset managers are causing the number of SMA offerings to continue to expand, they do not want these offerings to come from existing players, some of which are already household names. However, it's only the existing players that have the resources to bring product to market.
Mark Elzweig, president of Mark Elzweig Co. a New York-based search firm specializing in the SMA industry, said financial intermediaries within elite private client groups are constantly looking for new SMA providers, but "most new portfolios come from existing players," who are willing to offer discounted prices, Elzweig said.
Nonetheless, senior management at the big SMA distributors -- most notably Merrill Lynch, Morgan Stanley, UBS and Smith Barney, which control more than 70% of the assets under management in the industry -- is less concerned with offering new portfolio managers than institutionalizing their sales processes.
"Right now, there are more managers than the business can support," said Mike Evans, a senior analyst at Financial Research Corp, Boston. "Today, the client in a separate account is sold on the process instead of the product."
But there is hope that smaller asset managers will have renewed interest in diversifying SMA offerings, and should that happen, it could put money managers in a better position to negotiate fees. While fee compression is arguably stepping up the rate at which smaller asset managers are leaving the SMA business and heading into mutual funds, fees in this area have been dropping, too. And the decline in mutual fund fees might stop some SMA managers from abandoning the business, according to Gordon Forrester, director of marketing at Putnam Investments.
Finally, big asset management firms realize the importance of maintaining a strong presence, or full investment lineups, in both the mutual fund and SMA industries. Their expanded presence may ultimately offset the vacuum created by smaller managers retreating from falling SMA management fees -- and put SMA managers back in the driver's seat, Forrester said.
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