this genre, the program currently lacks ongoing securities coordination across styles, although Russell does attempt to avoid securities overlap through a sophisticated front-end manager investment-style research method.
Cerulli Associates believes that the industry is just beginning a prolific separate account product development initiative. They expect more single- account MSAs, and they anticipate important advancements in technology and underlying securities coordination that will enable multiple accounts run by multiple unaffiliated managers to be managed as a single portfolio.
These products are poised to play an integral role in a client’s total invest- ment portfolio, where the separate account would serve as the neural net- work, or clearinghouse, for the client’s full range of investments. Industry efforts are already under way to make this happen. As an example, Lock- wood Financial, an early advocate of the control account concept, is restruc- turing its platform to incorporate the tax ramifications of investments outside of one’s managed account portfolio. As this takes hold, it will further strengthen the power of the UMA and provide an additional boost to the popularity of managed accounts.
look like a sponsor. Basically, the only missing piece is the front-end process of coordinating the sponsor’s internal offerings with the investor’s other long-term holdings. We would not be surprised at all to see a large money management firm or mutual fund company purchase a smaller sponsor to acquire this front-end capability.
Large sponsors will realize that, with less perceived value in manager selection, they may want to internalize portfolio management. This would dramatically increase their margins and allow them to compete more aggres- sively with the new super–money managers.
The largest current sponsors (wirehouses) are already part of firms that have large proprietary asset management capabilities. You might see them start to feature those capabilities in their control account program rather than their external manager alternatives. You might also see sponsors start to acquire smaller money management firms to build a core offering. Once again, the distinction between sponsors and money managers will fade.
The large players will have tremendous economies of scale, making it very difficult for the smaller players to compete. As long as the separate account industry charges fees on assets, the large players will have a major advantage:
They will have the ability to bring prices down to a level that makes entry into the business extremely difficult. This phenomenon has already begun. In the past three years, a number of smaller sponsors have either been squeezed out of business or into someone else’s separate account space.
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C H A P T E R
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What Does a Separate Account Cost?
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isunderstood pricing is probably the single greatest factor that has retarded the growth of separate accounts over the past 20 or more years.While the original 3 percent wrap fee was higher than the 1.5 percent generally associated with mutual funds or 1.0 percent for institutional money managers, the fee was actually a bargain because the execution costs involved with these other products often resulted in costs that were substantially higher than 3 percent.
Unfortunately, the fee became the defining element of the product—much like load, no-load, and 12-b mutual funds—and the separate account became known as the wrap-feeaccount. The financial press immediately latched onto the 3 percent fee and nicknamed the wrap fee account the “rip-off account.”
The attacks were unwarranted as it was an apples-to-oranges comparison, but the damage was devastating and sticks, to some degree, today.
What the press overlooked was that the fee included:
■ The money manager
■ The sponsor firm
■ The custody and execution
■ The advisor-consultant
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Over the last 20 years, rapidly changing technology in the industry has challenged the very premise of the wrap-fee structure. The cost of monitoring accounts and of record keeping is dropping. From the manager’s side, changes in technology have also led to decreased costs in executing transac- tions and portfolio management.
When someone wants to pull the comparison card, you can say: The sepa- rate account is one of the few financial products for which the entire fee is disclosed up front in a straightforward manner; furthermore, this fee is visibly highlighted each quarter.
Other products have hidden (or at least less visible) costs. Actually, pricing in the securities industry is a mess due to the never-ending quest by financial institutions to hide fees. Most investors are totally unaware that they’re pay- ing added-on expenses because the extra expenses are hidden in the net cost.
Many of the top separate account managers have minimum account sizes of
$1 million or more. But under the wrap programs, they take lower minimums.
According to Morningstar, the average expense ratio for a domestic equity mutual fund is 1.40 percent. This expense ratio does not include transaction (brokerage) costs. For the 10 largest domestic equity funds, the average bro- kerage charges are 0.13 percent, bringing the total costs to approximately 1.53 percent (an average-sized fund could have a much higher total cost, as the 10 largest funds enjoy economies of scale in their costs). For a $100,000 managed account, the management, brokerage, and program fees can total approxi- mately 1.25 percent. (Neither of these total cost numbers include the financial advisor’s fee, which is variable and controlled by the independent advisor.)
The media would never believe this, but it is entirely possible to buy a sep- arate account investment for less money than its mutual fund alternative.
Due to the current complexity in pricing, in order to figure out the best way to purchase funds, consumers must rely on professionals with specialized software to process all the multiple variables. To add to the confusion, there are management fees, commissions, plus combinations of the two. Some bro- kerage firms offer the choice of either commission or one fee that includes a certain number of trades. The problem is that each fee structure is designed in a vacuum. The end results are client confusion and skepticism.
The solution is clear: All fees should be spelled out, broken down, and listed in their component parts. Bare-bones management and administrative costs should be detailed. Supermarket charges and markups should be highlighted as additional, as should any distribution charges paid to a financial intermediary.
The same applies to wrap fees. The financial intermediary fee should be estab- lished and declared, with custody fees stated. The money manager’s fee should also be disclosed. Each component should be broken out so clients can make a determination of where the costs are incurred and where the value is received.
160 THE PROCESS
The consultant can then charge a fee for advice, whether the client invests in separately managed accounts, mutual funds, variable annuities, or other packaged products. This eliminates the consultant’s incentive to sell one product over another, and the client is assured that what’s recommended is in his/her best interest. Disclosing the component parts of the fee to the client will have the effect of driving costs down as individual managers compete for the business on the basis of fees. Finally, fees for each of the components will fall as the accounts increase in value.