Downmarket thrust lifting separates up

When it comes to separately managed accounts, the big question these days might be: How low can they go?

Technological advances, combined with some aggressive marketing efforts, are driving this once- exclusive investment category ever deeper into the retail-investor ranks.

With minimums as low as $25,000 in some programs that package a diversified mix of money managers, the industry is experiencing a kind of second-generation growth spurt.

According to Financial Research Corp. in Boston, multistrategy- account assets, as a subset of the $400 billion separate-accounts industry, skyrocketed 55% to $17 billion during the fourth quarter of last year.

This is generally being interpreted as good news, particularly after a three-year bear market, and much of the credit is being given to the flood of new multistrategy programs.

“This is where the separate-accounts industry is going,” says Robert Brown, chief investment officer at GE Private Asset Management in Sherman Oaks, Calif. “We don’t view [multistrategy accounts] as being different; we view them as being the logical next stage of separate accounts.”

a lot of hype

But some observers say the industry’s recent stampede of new multistrategy programs may be going too far, that the true benefits of separate-account management are being lost amid the marketing hype as the industry essentially reinvents the mutual fund.

Leonard Reinhart, president of The Bank of New York Co. Inc.’s Separate Account Services Inc. division in Malvern, Pa., says that despite attracting smaller accounts, the newer programs may not necessarily be the best investments for either the industry or investors.

“At this point, I think we’re in a market where [companies] are so desperate to capture assets that they’re going to do this even as a loss leader,” he says. “With these smaller accounts, there’s not a lot of profit margin, if any at all.”

Mr. Reinhart, who founded and oversees Lockwood Financial Group, a Bank of New York subsidiary in Malvern, says Bank of New York’s separate-accounts business has reluctantly started offering a multistrategy program.

“We’ve held off until now because I’m not the biggest fan,” he says.

Even as his division is beginning to offer multistrategy accounts for a $200,000 minimum, Mr. Reinhart challenges the value of such a program.

“For smaller accounts, I wonder what the value-added is between [a multistrategy account] and a total-return mutual fund,” he says. “There are a lot of good mutual funds out there.”

While separately managed accounts for individual investors can be traced back at least 30 years, the first multidiscipline account was created by Citigroup Asset Management of Stamford, Conn., about five years ago.

Citi’s MDA program, sold through its affiliated Smith Barney brokerage force in New York, exploded onto the scene by offering investors access to a portfolio of money managers for a $150,000 minimum investment.

Before Citigroup’s MDA, most separate accounts set minimums at $250,000 for access to a single style. Thus, investors needed at least $1 million in order to create a diversified portfolio.

Citigroup’s innovation proved to be advantageous, as the company is still responsible for about 90% of all multistrategy-program assets.

Yet the field is gaining new competitors at a steady clip.

According to Cerulli Associates Inc. in Boston, 21 firms offer some variation on the multistrategy program, with investment minimums ranging from $25,000 to $300,000.

“Over the past 18 months, we’ve been hearing a lot of firms making noise about entering this business,” says Jack Rabun, a Cerulli analyst.

Like conventional separate accounts, multistrategy programs emphasize individual account customization, which typically includes tax loss harvesting and the ability to exclude certain stocks from an investor’s portfolio.

Although there is no universal model, most multistrategy separate-account programs use an overlay manager to execute trades and guard against taxable events such as wash sales created by two money managers buying and selling the same security within a 30-day period.

David Stein, chief investment officer of Parametric Portfolio Associates in Seattle, says the overlay technology creates flexibility and enables money managers to manage a larger number of smaller accounts efficiently.

Parametric, which manages nearly $5 billion in separate-account assets and is being acquired by Eaton Vance Corp. of Boston, entered the overlay-management business less than a year ago to capitalize on the growing trend toward smaller account management.

Yet Mr. Stein acknowledges that some of the smaller accounts could be better served through mutual funds.

“I’d like to think that what’s driving the popularity of [multistrategy accounts] is the need for customization,” he says. “But what’s actually selling it is the marketing. There’s a lot of people out there marketing this. In reality, for a lot of people, a mutual fund is probably better.”

At Brinker Capital Inc. in King of Prussia, Pa., the multistrategy-account program splits individual shares of stock into fractions to ensure that larger accounts get exactly the same allocation to a particular strategy as an account with a $25,000 allocation.

“Fractional shares allow us to combine the best features of mutual funds with the best features of managed accounts,” says John Coyne, a Brinker principal.

Of course, as technology makes it possible to manage hundreds of identical smaller accounts, the industry may struggle to distinguish itself from mutual funds.

“The more standardized the product, the more it starts to look like a commingled vehicle – a mutual fund,” says Mr. Brown of GE Private Asset Management.

Being confused with an ordinary mutual fund risks deflating the mystique of the separate-account strategy and opens a Pandora’s box of regulatory oversight.

The ultimate distinction between mutual funds and multistrategy accounts will likely come down to the level of customization.

The problem is, as Mr. Rabun of Cerulli points out, the incentive to customize decreases in proportion to the shrinking account size.

“These companies can make use of technology to offer $25,000 account minimums, but the lower you go, it only magnifies the difficulties for everyone to make a profit,” Mr. Rabun says.

And for financial advisers, who may find the multistrategy accounts an easy product to sell, Mr. Rabun says, the continuing maintenance of the smaller accounts could prove to be exhausting.