More investors (w)rap to a fee-based beat

Fee-based advisory relationships have emerged over the past year as safe harbors in a stormy market.

Mutual fund wrap programs that charge a flat fee for allocating client assets across various model portfolios grew by more than 50% last year to $150 billion, according to the latest research.

Avi Nachmany, director of research at Strategic Insight Mutual Fund Research and Consulting LLC in New York, calls the strong net inflows evidence that the fee-based model works, particularly when the markets are more challenging.

He says the numbers are proof that, across the financial services industry, brokers and advisers are steadily shifting their clients to fee-based platforms.

“Now that the era of legalized gambling is over, the environment has totally shifted to the realization of the cost of being on your own without an adviser,” Mr. Nachmany says.

Mr. Nachmany, who led the research showing net inflows into mutual fund wrap accounts topping $50 billion last year, says 2000 was a “watershed year for mutual fund wraps.”

Popularized during a gradual shift toward fee-based advice over the past decade, the mutual fund wrap program has become a tool to help commission-based brokers make the transition to a fee-based way of doing business.

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The mutual fund wrap is ideal for such transitions because it provides the advisers with various allocation models made up of mutual funds that can often be customized to meet specific investor needs.

American Express Financial Advisors, the Minneapolis financial planning division of American Express Co., paced the mutual fund wrap industry last year, with $8.6 billion in net inflows and 85,000 new accounts.

AmEx’s total mutual fund wrap assets of $17.1 billion at yearend still lagged behind those of SEI Investments Co., the market share leader, which finished the year with $23.6 billion.

SEI of Oaks, Pa., saw mutual fund wrap inflows of $7.8 billion, while adding 25,000 new accounts, according to Strategic Insight.

The Pershing division of Donaldson Lufkin & Jenrette Securities Corp. – now part of Credit Suisse First Boston – and LPL Financial Services rounded out the top four asset gatherers, with net inflows of $6 billion and $2.8 billion, respectively.

As Mr. Nachmany points out, advisers in fee-based relationships are probably a lot happier today than their commission-based counterparts.

“In a down market, the velocity of decision-making is greatly reduced,” he says. “As a result, the transaction-based revenues are greatly reduced.”

Mr. Nachmany’s research suggests that independent broker-dealer firms and financial advisers were responsible for most of the mutual fund market’s growth.

“Such programs provide the rep not just with a list of asset-allocation models to select from, but also with portfolio-building software and other tools to empower him or her to provide maximum customization for the clients,” the report states.

revenue share rising

Mr. Nachmany says that at independent broker-dealer firms, the share of managed assets – primarily mutual fund wraps – now accounts for more than 12% of revenues – double the percentage from such programs five years ago.

“The consumer is saying they don’t mind paying for advice, but they want it to be fair,” says Aaron Cull, manager of advisory marketing for LPL, which has headquarters in San Diego and Boston. In a fee-based relationship, the adviser is compensated based on the performance of the portfolio.

He adds that many erstwhile commission-based brokers prefer mutual fund wraps to the higher-end separately managed accounts because of the ability to customize and manage the portfolio.

“With separate accounts, you’re just throwing the assets over your shoulder and letting somebody else manage it,” he says.

Of course, fee-based relationships introduce the added challenge of justifying an annual fee, typically around 1%, even when the account is losing money.

Mr. Cull says that if advisers are doing their job, advice goes way beyond allocating investments into areas more related to estate and retirement planning.

“The great markets are great for selling, but you have to be able to play offense as well as defense,” says Carmen Romeo, executive vice president of SEI.

Mr. Romeo admits that it has always been a problem for investment professionals to explain performance in a down market. But, he says, “it’s important to explain to the clients that things would have been even worse without an adviser.”

Contrary to early speculation that fee-based relationships might come under pressure in a down market, Mr. Nachmany points out that, when times are tough, investors will pay for good advice.

SEI is affiliated with 3,500 independent broker-dealers and financial planning firms that sell the wrap program. Mr. Romeo says 7,000 individual advisers have sold the company’s wrap program, which provides the intermediary with tools to construct more than 30 different portfolio models.

Mr. Romeo says SEI doesn’t like to call its service a “wrap” because the company is emphasizing the holistic approach to financial planning that includes “a whole series of life-cycle events.”