The next big thing in investing roars up evolutionary ladder

Nearly 30 years after their creation, separately managed accounts suddenly have been “discovered” by the financial services industry.

The result is something akin to a land-grab mentality. Companies of all kinds are scrambling for a stake in a market that is projected to more than double over the next four years.

But the evolution has turned downright frantic and, some say, it’s fraught with pitfalls.

As account minimums decline, the industry is starting to butt heads with the mutual funds, which could lead to a call for greater regulation.

In the rush to launch separately managed accounts, due diligence also may become a casualty.

“I’m worried that some firms just looking to gather assets may not be doing the highest level of due diligence on the money managers,” says Chris Davis, executive director of the Money Management Institute, a Washington association set up five years ago to represent the fast-growing industry

“As more money managers hold themselves out as capable, due diligence has to be high level,” he adds.

Dynamic growth

From money managers to brokerage firms to web-based enterprises, it is difficult to find an operation that is not upgrading or building a brand-new separately managed accounts business.

“Evolution is good,” says Mr. Davis.

“I would be the most disappointed guy in the industry if what I was seeing in the separate-accounts industry today was the same as it was four or five years ago,” he adds.

“All kinds of things are happening right now, and that tells me this is one of the most dynamic areas of the financial services industry.”

Calling it dynamic actually might be an understatement.

The $319 billion in total separate-account assets represents a 182% increase since the end of 1996, according to Cerulli Associates Inc. in Boston.

The consulting firm is projecting assets to grow at an average of nearly 21% per year through 2005, bringing the total to more than $680 billion.

By comparison, total long-term mutual fund assets grew by 78% to $4.7 trillion between 1996 and 2001. After peaking at $5.2 trillion at the end of 1999, mutual fund assets have declined by more than $545 billion.

There are clear industry leaders. Citigroup Asset Management, based in Stamford, Conn., outpaces all money managers, with more than $70 billion in separate-account assets, and five wirehouses combine for 70% of all sales.

But other companies are angling hard for a piece of the market.

Lockwood Advisors Inc. in Malvern, Pa., has plans for an elaborate new multi-investment-strategy program, to kick off next month with a six-week, 36-city promotional road show.

“There are all kinds of estimates of how much this industry can grow,” says Lockwood president Chris Tomecek. “Between now and 2010, it could easily be over $2 trillion.”

SEI Investments Co. in Oaks, Pa., launched its separate-accounts platform in April 2001 with a goal of bringing in $1 billion in the first year.

The program, which offers access to 17 money managers and 10 investment styles, finished its first year with $2.2 billion. The company plans to lower the minimum-investment requirement to $100,000, from $250,000, at the end of this month.

Preparing for the longer term, SEI plans to introduce alternative investments such as hedge funds inside separate accounts by the end of the year.

Phoenix Investment Partners Ltd. in Hartford, Conn., is working to package insurance, variable annuities and even private investments inside separate accounts to better serve the needs of wealthier clients.

Affiliated Managers Group Inc. in Boston announced in January a partnership with First Union Securities Inc. in Richmond, Va., that includes offering separate accounts that blend multiple strategies from different money managers.

The new program is just getting its footing, but both companies already are planning to expand their reach by actively looking for more partnerships.

Nate Dalton, executive vice president of AMG, says he wants to have at least one more distribution relationship in place by the fall.

At First Union Corp. in Charlotte, N.C., senior vice president Burt White says product development is constant when it comes to separate accounts.

“The pent-up demand is crazy,” he says. “We’re talking about the next generation before this generation even goes mainstream.”

Jury’s still out

In essence, separate accounts are the new hot button, and all stops are being pulled to tap the channel – even at the expense of mutual funds.

“I’ve got to believe that separate accounts will bite into mutual fund assets a lot more than people think, and people think it will bite into it a lot,” says Mr. Tomecek.

Others are taking a more diplomatic tack on the controversial subject of how much separate accounts are eating away at mutual fund assets.

Jack Sharry, president of the private-client group at Phoenix, says mutual funds and separately managed accounts can exist side by side in the financial services universe.

“My personal view is that it’s not managed accounts or mutual funds; it’s both,” he says. “But I do believe there will be some cannibalization of mutual funds.”

Kevin Keefe, an analyst at Financial Research Corp. in Boston, points specifically to the latest variation on separate accounts as evidence that the mutual fund industry is taking a direct hit.

He says the multistrategy programs, which package more than one investment style to create a diversified portfolio for as little as $100,000, go after the same market as mutual fund wrap programs.

Created and patented five years ago by Citigroup, the Multi-Discipline Account took off like a rocket last year, becoming the symbol of all that is good about separate accounts.

It’s a turnkey wealth management tool sold exclusively through brokers at Citigroup’s brokerage subsidiary, Salomon Smith Barney Inc., based in New York.

Of the $15 billion that Citigroup’s MDA has attracted over the past five years, more than half of the assets came in 2001.

Senior-level managers across the financial services industry, drawn by Citigroup’s success, are falling over themselves to get their own multistrategy separate-account programs up and running.

But as Mr. Keefe gently points out, the jury still may be out on multistrategy programs.

“Just because you can do something doesn’t mean it’s a good idea,” he says. “It’s tough to draw a lot of contrast between [multistrategy separate-account programs] and mutual fund wraps.”

Mr. Keefe says it is too early to tell whether multistrategy programs will be able to maintain the kind of momentum established by Citigroup’s MDA last year.

One rub against the multistrategy approach right off the bat, he says, is its move downmarket.

That chips away at some of the exclusivity that separate accounts offer to investors who want to feel as if they are rising above the masses of retail investors.

“They’re being sold a lot like mutual funds,” Mr. Keefe says. “There’s a pretty fixed universe of options, and they are much less customized” than traditional separate accounts. Until a few years ago, traditional accounts required minimum investments in the $300,000 range.

Mr. Davis of the Money Management Institute thanks advances in technology for creating so many variations of separate accounts with such dramatically reduced minimums.

And he feels the next wave of the evolution could include the introduction of alternative investments.

`Pepto-Bismol moment’

But at the same time, Mr. Davis is conscious of the pace of change unfolding before his eyes.

Minimum account sizes, he says, may be too low already and could be poised to swing in the other direction.

And in what he calls his “Pepto-Bismol moment,” Mr. Davis admits that the industry may be in need of some kind of self-imposed standards.

The institute will take its first steps toward addressing the issues related to growth, due diligence, technology and industry standards later this year in a series of white papers called MMI Perspectives.

But beyond white papers, there is little talk from industry insiders about regulatory oversight for separate accounts.

Compared with mutual funds, which are the most highly regulated investments on the market, performance reporting and transparency requirements are far lower for separate accounts.

“Part of the reason for the popularity of separate accounts, strangely enough, is their lack of performance transparency, compared to the total transparency of mutual funds,” says Burton Greenwald, a Philadelphia-based financial services industry consultant.

Mr. Keefe of FRC predicts that if the separate-accounts industry continues along the path of constructing packaged products with lower minimums, it could be inviting a closer look by the Securities and Exchange Commission.

“The SEC gave separately managed accounts a carve-out so they wouldn’t have to be regulated, but these [multistrategy accounts] are looking even more like mutual funds,” he says. “Some people think it could have a regulatory impact.”