Although the big wirehouse sponsor programs are very determined notto lose the control they currently have, they inevitably will. The big sponsors are fighting the movement to improve operations because the poor state of that side of separate account functionality is distinctly in their favor.
Ultimately, however, this will change. We’ll see trading move away; we’ll see a custodial shift back to the fund companies. The fund companies will The State of the Separate Accounts Industry 43
handle separately managed accounts the way they currently handle mutual funds, and the operational problems will slowly disappear into the back- ground.
The bad news is that the operational mess in the back offices of some of the firms with which we’ve talked recently, along with some of the technology that’s currently being developed, could certainly lead the independent firms to challenge the status quo. They could challenge the dictatorial terms of the big-sponsor firms in terms of how a separate account is created. The same process is used to create a packaged mutual fund.
The typical pattern for technological development in this industry is that first, someone dips their toe into the water. Everybody else waits for a while, then they alljump on the bandwagon.
Eventually, the sponsor firms start losing their lock on control, the product becomes a little cheaper to create, the operations problems begin to go away, and all of that contributes to the ballooning assets. The independent firms are then able to contribute more dollars and more resources. It becomes eco- nomically viable for them to make a significant commitment to the separate accounts business.
The Biggest Challenge
The biggest challenge for the fund companies is operational, because there is no single standard for clearing in separate accounts as there is in the mutual fund industry. Also, fund companies have to learn how to provide individual attention to clients and to the representatives that put them into managed accounts. They will need to move from a transaction-based approach to a consultative approach.
Fund companies have learned that they can’t make a separate account mirror a current mutual fund they offer. For one thing, managed accounts hold fewer shares than similar mutual funds and often must be customized for the client. Managed accounts are meant to be tax efficient and, in general, hold fewer stocks.
On the side of the money managers themselves, there are things they are just now learning, such as true after-tax customization. Case in point: Suppose that a manager in today’s climate is successful and gets in all the right spon- sor programs. All of a sudden, the manager has 50 custodians, 50 new account procedures, 50 closing account procedures, and 50 trading desks with which to deal. Then the manager has all the error accounts with which to deal, and the list goes on and on. It’s going to be a nightmare!
This is where standard operating procedures step in. Lockwood’s Len 44 THE BASICS
Reinhart refers to the current landscape as a fiefdom.He likens it to Jurassic Park—“Life finds a way.” One broker moves to another firm. A manager gets into another program.All of a sudden, it gets all mixed up.And we’re left with this archaic system supporting these new fiefdoms.
There are no standard operating procedures and nothing in the way of infrastructure compared with all of the other financial products in the indus- try.Theseare the issues that the industry continues to tackle and which it will work through.
Note
1This information was used with permission from the Cerulli ReportSeries. Cerulli Associates’ latest report,Asset Management: Operations and Profitability Bench- marks for Separate Account Consultant Programs,presents the managed accounts industry with a comprehensive benchmarking study on the operations, technology, and profitability of the separate account consultant program business.
The State of the Separate Accounts Industry 45
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C H A P T E R
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Participants in the Separate Account Market
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nvestors whose needs can be fulfilled by separate accounts are usually characterized as high net worth.This generic grouping is often separated into at least three segments:1. Semiaffluent. Investors with roughly $200,000 to $500,000 in investable assets.
2. Affluent. Investors with roughly $500,000 to $5 million in investable assets.
3. Superaffluent. Investors with multimillion-dollar portfolios, at least
$5 million in investable assets.
The ideal target client is between 45 and 70 years old, has a net worth of $1 million or more with at least $500,000 of assets to invest, and needs compre- hensive financial planning.
Of this high-net-worth market, 95 percent falls into the semiaffluent cate- gory, which includes 48 percent of U.S. investable assets. This market is where many financial advisors have placed their focus. Unfortunately, mass adver- tisement has inundated this group, making it very difficult to have a com- pelling story of differentiation.
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The affluent category represents the fastest-growing area, comprising about 4 percent of the market. This category continues to be a sweet spot, although competition is significantly increasing.
Three years ago, the superaffluent segment represented 0.1 percent, or about 100,000 households. Today, it numbers 200,000 households and is still growing.
Affluent investors are noted for being less price- and performance- sensitive than either general retail or institutional investors. Financial and investment management for the affluent is more of a relationship business.
The high-net-worth client wants to develop a face-to-face, interpersonal rela- tionship with an advisor who can provide turnkey financial management, problem solving, and peace of mind.