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.
Separate account managers who do not go through a sponsor can typically charge 1.0 percent. Managers who participate in a sponsor program are typi- cally paid (for equity and balanced accounts) a high of 65 bps, scaling down to 30 bps. The larger sponsor programs are at the bottom of the scale. The large program sponsors also pay the manager a de-escalating fee based on the total assets the manager receives. For instance, on the first $250 million the man- ager receives 50 bps, on the next $250 million 45 bps, and so forth.
The starting point for the fee will vary from sponsor to sponsor based on the services the sponsor provides to the manager. There are dramatic differ- ences among sponsor services provided to the money manager. For instance, does the sponsor pay for, provide, and reconcile a portfolio management record-keeping system or just provide a data dump? Many money managers today overlook these differences because gaining entrance into major spon- sor programs is extremely competitive. However, as more separate account distribution channels become available, this shortsighted approach should cease. If it doesn’t, the managers will find themselves in the position of a favored-nations-clause nightmare, being forced to accept rock-bottom prices even when the sponsor provides little service.
2. The sponsor. Sponsor services vary both to the advisor and the in- vestor, as well as to the money managers whose services they distribute. The most common services provided by the sponsor are:
■ Research on money managers
■ Asset allocation
■ Separate account generation
■ Client reporting (statement/performance)
■ Account administration
■ Billing
■ Consultant interface
■ Account set-up
Optional sponsor services are:
■ Fiduciary responsibility
■ Portfolio design teams
■ Trust services
■ Consultant training
■ Portfolio record keeping 162 THE PROCESS
■ Reconciliation
■ Regulatory compliance
■ Internet access to account data
Due to the various services, the fees vary but are quoted on an account or household level, not on total assets.Typically, on a $500,000 household, fees will range from 25 to 65 bps. As account size increases, the fee drops substantially.
Sponsors can be eliminated, but the core services must still be delivered. A money manager working directly with the investor or advisor-consultant has to perform the majority of the core services, making them a de facto sponsor, or supermanager. Fees for this type of relationship are higher.
The traditional sponsor will have to go through the most changes to the separate account components over the next decade. The large sponsor will be forced to move from what has been a very closed process to an open- architecture platform. Along with an open-architecture platform will come unbundled pricing of services. As this pricing evolves, true value comparisons can be made. Similar to the money managers, sponsors are currently pricing to what the market will bear, not on services provided. This has forced many of the traditional smaller sponsors out of business. They have not been able to demonstrate superior services that would justify a premium price.
3. Custody, clearing, and execution. Until recently, these services were bundled into the overall sponsor fee, making the actual costs almost impossi- ble to determine. Due to sponsor entrants who do not self-clear, these costs are now being identified. In most cases, they are quoted in basis points (bps) on an assets-per-account basis rather than on total assets (money manager) or household (sponsor). For a typical $250,000 account, clearing, custody, and execution come bundled at between 20 and 40 bps.
These services are, in most cases, considered a pure commodity:
■ Custody. The actual separate account securities storage and offi- cial record keeper. Traditionally, this has been the role of the bank.
■ Execution. Execution of buy and sell orders from the money man- ager, which has generally been the role of the stockbroker.
■ Clearing. When the manager executes a block trade of stock for multiple accounts, it must be delivered to the custodian and placed in the proper account, which is the clearing function.
Clearing, custody, and execution are performed by the separate account sponsor. This means that for a money manager in 20 sponsor programs who wants to buy a stock across all accounts, they must place 20 orders of the What Does a Separate Account Cost? 163
stock at the same time, one at each sponsor/custodian. This practice is ripe for change as it is simply not efficient; investors who have the same separate account manager, but different sponsor custodians, will get different execu- tion prices. As of this writing, the Securities and Exchange Commission (SEC) plans to review these trading practices.
In the future, execution will be separated from custody and clearing. The manager will place one block order at the institution that has the best execu- tion and the 20 smaller blocks will be cleared to each sponsor/custodian. This will ensure the best execution.
As separate accounts revamp their trading procedures to this new stan- dard, you will see commissions on stock trades reappear. The separate account will have come full circle in 25 years. Once execution is unbundled, the market for best execution will take off.This market will be trade-by-trade, depending on difficulty, making bps pricing for execution impossible.
This may seem like a step backward, but it is not. Executions will be better for the investor. The cost of execution is close to zero on big block trades anyway.Also, as execution is stripped from the custodian, the bundled fee will decrease dramatically. One major clearing firm is already doing business with a 5-bps custody charge and competing for executions at $5 per trade.
Unbundling of the separate account pricing will continue. Even the large wirehouse sponsors will have to unbundle the manufacturing expense from the advisor fee so they can accomplish their consulting umbrella strategy.
Unbundling within the four major categories will also begin so that an apples-to-apples comparison can be made. Due to regulatory pressure, this will probably begin with the area of custody, clearing, and execution. As the lines between money managers and sponsors blur, it will force the other cat- egories to unbundle.
Unbundled execution will also solve another problem. Currently, spon- sor/custodians lose money on some very active managers, but make enough on the lower-turnover managers to make the total business profitable. This means that investors with low-turnover managers are subsidizing investors with high-turnover managers. This is not only unfair to the investor, it creates artificial businesses. There are extremely high-turnover managers in the industry that would not survive competitively if the actual trading costs were factored into their performance. Unbundling execution will solve these inequities and be a major benefit to the investor.
4. The advisor-consultant. This group is relatively straightforward. The fee received for servicing the account in the traditional large sponsor is wrapped into the bundled fee. In the independent advisor world, the fees are 164 THE PROCESS
distinct. The typical advisor charges between 40 and 100 bps, based on house- hold size. The average fee on a $1 million household is 68 bps.
This fee tends to differ by professional evolution. That is, an advisor who grew up in the brokerage business is on the high end. Advisors who came out of the accounting world are on the low end. If the advisor’s core business is investment consulting, he/she tends to charge more than if it is a secondary business to the core business.