Managed Accounts Without the Headaches

For all the proselytizing by wirehouse management and leading consultants about the virtues of selling separately managed accounts, the fact is that — for the most part — the only brokers who got religion were the reps in corner offices with multimillion dollar portfolios. Managed accounts have been too complex and too costly for most clients. There was no way a broker with a $300,000 account could call a Brandes manager and ask him to figure out how to solve his client's tax problems.

That's changing. During the last year or so, scores of firms have introduced products and services that make it easier for all reps to handle managed accounts. In particular, new technology automates the task of handling the tax complexities for thousands of $200,000 accounts, as money managers shift positions. Also, while many managers operate tax-efficient portfolios, tax events arise that are different for each individual client. Dealing with that is a broker's nightmare.

If the technology works as promised, selling and administering managed accounts could be far easier for reps. “The managed account space has had fairly weak technology for 20 years now,” says Chip Roame, president of consultancy Tiburon Strategic Advisors, of Tiburon, Calif. “The good news for brokers is that good new technology is coming. I think we've been underdelivering in this space.”

It's still early, but reps are noticing the difference.

“I was skeptical going in,” says Gordon Porter, a Securities America rep in York, Pa., who is using his firm's recently introduced platform, designed by Oberon Financial Technology. “I'd shied away from managed accounts in the past…the system was so cumbersome and bureaucratic; now it's a lot easier.”

Why All The Fuss?

Everyone's heard the numbers. Managed accounts are poised to be the fastest growing phenomenon since Pokemon. Financial Research Corp. is expecting assets to grow to $1 trillion in less than three years from just $400 billion currently.

That will only happen, Wall Street executives concede, when managed accounts require less of the reps that have to sell them — when they can place client portfolios with the appropriate managers without worrying that tax issues and restrictions are going to be ignored, and then get back to gathering more assets. Today, the business is too high maintenance.

“When you involve multiple accounts is when you involve cross-checks and overlays, and the onus for that is on the FA right now,” says Jim Quartuccio, vice president of operations at Prudential. “Probably one of the most fundamental, toughest challenges in this industry is figuring out how that works on the tax side.”

This is where more than a dozen technology companies have jumped in to take on some of the complex calculations that money managers can't handle, while also providing tools that make it easier to explain separate accounts to clients and to manage them.

Unlike such established separate account managers as Brinker Capital and Lockwood Financial (just purchased by The Bank of New York), these companies operate a bit more in the background. They offer firms the chance to provide broker/dealers with privately labeled platforms that offer a suite of separate account managers, along with Web-based account viewing, enhanced performance reporting, a centralized location to custody assets and greater tax efficiencies.

Many of the firms focus on the advisor, attempting to provide them with tools that make it easier to open accounts and ease the process of picking managers. They all have their wrinkles. Some, like Oberon Financial Technology, FundQuest, and ADVISORport, provide turnkey asset management services, while Separate Account Solutions provides a custom-built platform for institutions that already have many resources that independent broker/dealers don't have. Others provide these services, but concentrate more specifically on tax optimization and overlay management, such as Tamarac, Axioma and Placemark Investments. Many large independent broker/dealers have signed up with these companies, instead of building their own platforms.

This Stuff Should Be Easy

There are a few simple problems that these companies are trying to solve first and foremost, while enhancing the advisor's ability to involve themselves in the process of using separate accounts.

For example, Oberon's platform shepherds the broker through a five-step process designed to ease the burden on the advisor to set up separate accounts by giving them best suggested choices on managers for a particular client and allowing substitutions based on the client's particular risk portfolio. Platforms similar to Oberon, such as NetAssetManagement, reduce the process of account opening to a short questionnaire that produces a risk tolerance and investment profile and generates an investment policy statement in a quick manner.

Previously, the simple process of opening an account was ridiculously time-consuming — a client would need a separate brokerage account for each individual third-party money manager; that's a heck of a lot of unnecessary paperwork. Many platforms have simplified this to a process that only involves taking down client information once and duplicating it if necessary. Gerrald Giblin, a rep with Sandeen & Giblin in Houston, who uses FolioFN's managed accounts product, says now he's “opening one account, which is nice, compared to the other platforms we use, where you still have a different brokerage account for each different money manager.”

The programs also provide research on selecting managers, offering up the ability to substitute managers that one broker might find to be a better fit for a particular client. Ultimately, advisors are able to produce an investment policy statement for clients that includes a risk profile and an asset allocation model. Here, on products such as FundQuest, brokers also have the opportunity, if they wish, to set up account restrictions and plug in particular tax needs that a client might have.

“If I've got a wealthy investor with five or six losses in the portfolio, and if they want to harvest those losses to offset other gains, I can do that. I couldn't before,” says Joe Gunther, a Securities America rep in Oneonta, N.Y.

Another hardship that broker/dealer execs were dealing with was having to account for several managers on different platforms, with different performance standards, without an easy way to consolidate the figures for a client (wirehouses, because they control significant amounts of managed assets themselves, have fewer problems with this). While one could simply use one third-party manager platform, brokerage execs felt that would limit the possibilities for diversification.

Dennis King, vice president of business development at Securities America, says his reps needed an easier way to deal with logistical difficulties of working with different managers. “The outsourcing of money management responsibilities is a business model we like, but there are some inherent problems in that model,” says King. “Assets were custodied at several locations, clients got several statements, you can't aggregate the assets — it's difficult to supervise from a compliance perspective.”

Platforms like Oberon place the money managers in a sub-advisory role and put the custody of assets in the hands of the sponsor (the broker/dealer). Viggy Mokkarala, executive vice president at Oberon, says this method enhances the ability of the advisor to set up account restrictions, as well as handle performance reporting more efficiently.

The system consolidates the individual performance of each manager into one — albeit lengthy — performance report for clients. Reporting is more frequent (once a month, with a longer quarterly version) and clients can use the Internet to access a detailed account statement. Many of the newer platforms also allow for significant customization in the hands of the sponsor; if a manager isn't available on a platform, they can be made available.

All About the Taxes

One aspect of managed accounts that's been a continuing bugaboo is providing the best tax efficiency to a client while still allowing them diversity among several managers. Multistyle accounts attempt to do this, but at times they have inefficiencies as well.

“Some clients are really scared of paying taxes and sometimes even sacrifice some return to avoid some taxes,” says one Raymond James rep. “There are some managers in our system who are more tax-friendly than others. Some of them don't even think about taxes, while others are conscious of them and try to lessen the impact.”

Many separate account managers offer tax-sensitive options that pertain to their particular portfolio, but a manager's decision to sell stock can hurt one client while helping another.

And that doesn't even take into account the different issues that can come up when using an account with several managers operating independently. Often they can't account for the various existing assets a client may have that makes them want to harvest certain losses. In addition, money managers can't easily keep track of individual tax situations.

Two clients holding the same stock in a model portfolio may have a different cost basis, and a manager's decision to sell the particular stock may result in a negative tax event for one, but a positive event for another. Tax optimization strategies, like those employed by Placemark, Axioma or Tamarac's software, step in before a manager makes these trades and assesses them based on the particular client's tax situation.

“For the garden variety separate account, there's no coordination, and most of them don't have the technology internally to be [tax efficient],” says Mark Balasa, principal with private wealth management firm Balasa Dinverno Foltz & Hoffman in Schaumburg, Ill., who uses Tamarac's tax optimization software to manage his clients' accounts. “You have to ask whether they're coordinated with other separate accounts. The answer, invariably, is no.” Tamarac's software focuses on letting managers, or those reps that act as portfolio managers, handle their clients' individual tax situations.

Other firms, such as Parametric and Placemark, are trying to address the need to coordinate among managers of different firms where the rep doesn't act as the portfolio manager. Placemark's tax optimization strategy, for example, factors in securities not included in one's managed portfolio, even including assets such as real estate. The tax optimizer that Placemark uses puts that company in the position of deciding, ultimately, which trades are made and which are either put off or canceled altogether. If a manager wants to make a trade, Placemark's technology determines whether it's right for the accounts it is overseeing within a matter of minutes.

In a sense, that makes Placemark the übermanager. The addition of this overlay manager sometimes raises questions from brokers about who's really in charge — the recognized money manager or the behind-the-scenes platform provider.

“We do get that question, until we explain why that's not feasible,” says Lee Chertavian, Placemark's CEO. “Sometimes people will say, ‘Shouldn't I get pure Rittenhouse?’ and I say, ‘You can, but there's no way to do that and get the tax advantages that we provide.’” But as much as possible, we're trying not to have our investment judgment supersede that of the managers.”

The pitch of these companies is about helping brokers gain the tax efficiencies that motivate customers to go into managed accounts, rather than mutual funds.

This is Still Complicated

Not all the kinks have been worked out. Coordinating the various managers remains a bit of a chore, according to some reps, and some of the programs haven't been in use long enough to determine whether the much-proffered tax efficiencies will bear fruit.

“The rise of the ability to make them actually managed as separate accounts is one that is still in the early stages, and it is clearly a work in process,” says Tom Samuels, chief investment officer of Stavis/Margolis Advisory, a member of Royal Alliance, in Houston. He says, however, that the recently introduced Vision2020 Advisor, produced by NetAssetManagement, is a step in the right direction.

Among the complications folks like Samuels are still dealing with are overly complex tax structures that he and other advisors may want to implement. “There are restrictions more complex than simply saying, ‘no alcohol, tobacco or gaming stocks,’” says Samuels. He says complex strategies, such as, say, deferring taxes for a longtime Exxon vet in his/her hefty position in Exxon stock over several years, are still a tough nut to crack. “Say the stock goes from $35 to $45. How much do the timing issues overlap with your desire to spread out the tax basis over time?” he posits.

The worry Samuels and others have is that education on these issues hasn't reached the broker level. “A lot of advisors have a basic understanding, but some tell me that when they get it in front of a client, they say, ‘I'm getting hit with questions and I'm not sure how to answer them,’” says Chris St. Laurent, president of Vista Analytics, a Houston-based consulting firm that provides a separate account platform to registered independent advisors and regional broker/dealers.

Some say this is one reason why multidiscipline, or multistrategy products have become popular — because they're ostensibly easier to understand, but there are complications. Mixing managers from different companies is still difficult, but companies are already starting to address this — Parametric recently introduced an overlay management product to increase customization of multistrategy products.

At this point, there's still a lot of fragmentation in the industry, and a lot of debate on how to reduce some of the inefficiencies. Quartuccio of Prudential is part of a Money Management Institute committee seeking ways to standardize certain operations within the industry. That includes communications and standardized language in paperwork, and overall technology operations within the industry. MMI is also exploring whether the industry is ready to handle rapid growth of assets in the next five to 10 years. A white paper recently commissioned by the institute concludes that the industry is not as efficient “as we'd like it to be,” says MMI Executive Director Chris Davis.

The early word from advisors, however, is that the newer consolidated approach taken by the new products are helping them become more efficient.

“We can go with [the models] they suggest, or we can select them with the client,” says Gunther of Securities America. “The feeling before was that it wasn't even open to the registered rep or the client…the asset allocation company was the only one that could make certain choices.”