Morningstar takes shine to separate accounts

Coming, but not too soon, to a managed account near you – ratings.

Morningstar Inc., the company that revolutionized the mutual fund industry by telling you everything you always wanted to know about funds, is strongly considering plans to extend its services to separately managed accounts.

But it hasn’t quite figured out how to do it, and it could be up to three years before the service is launched.

“We’re getting a lot of calls from financial advisers saying, `I see a lot of compelling reasons to move into separate accounts, but I feel like it’s going back in time to the days of limited partnerships where I don’t have access to quality information,”‘ says Don Phillips, a Morningstar managing director. “We’re looking pretty hard at it.”

demand

If Morningstar decides to pursue the separate-account business, it will likely take a similar approach to the way it evaluates mutual funds – using measures such as performance and risk.

The company popularized mutual funds in the 1980s with easy-to-read reports and its much-copied five-star rating service.

It also came up with the “style box” that gives investors plain-English descriptions of how funds are invested.

“Why not evaluate separate accounts as if they were mutual funds?” asks Mr. Phillips, who confirmed the Chicago company’s plans in an interview with InvestmentNews.

Anthony Vargo, a financial adviser at Legend Financial Advisors Inc. in Pittsburgh, which oversees $100 million in assets, says Morningstar’s potential service would be valuable.

Using Morningstar to evaluate and rate separate-account managers “wouldn’t be that big of a leap for us,” Mr. Vargo says. “We are very comfortable with Morningstar.”

Currently, Legend relies exclusively on its own internal evaluation of separate-account managers.

“We have a questionnaire that we send to separate-account managers,” he says. “Another tool would definitely be a value-added.”

Managed accounts are becoming increasingly popular among wealthy investors. At the end of the first quarter, managed accounts had $670.7 billion in assets.

While that was down 7.7% from yearend – largely because of the stock market’s slide – it was up from $617.1 billion a year earlier, according to Cerulli Associates Inc., a Boston mutual fund consultant.

Managed accounts differ from mutual funds in that investors actually own the stocks and bonds chosen by the money manager. Mutual fund investors, on the other hand, purchase shares of an investment pool instead of directly owning them.

Managed accounts are popular because they are tax efficient and because advisers can tailor them to meet an investor’s particular needs.

Morningstar won’t be the first to evaluate money managers who oversee separate accounts.

Prima Capital in Denver already evaluates separate-account managers, as does Effron Enterprises Inc. in White Plains, N.Y. Morningstar would also compete with Mobius Group Inc. in Research Triangle Park, N.C. However, those firms evaluate separate accounts on a client-by-client basis. Morningstar hopes to rate separate accounts the same way it does mutual funds.

But therein lies the challenge – rating tailor-made funds with a general evaluation model.

“Advisers and wealthy individuals will not put too much credence on any type of simplistic, performance-based, star rating system,” says Gib Watson, chief executive of Prima Capital.

“You really have to be able to get under the hood and understand what makes a particular manager tick.”

Getting under that hood isn’t easy. Information on separate accounts is not readily available.

“Separate-account managers generally do not provide information to firms that do not have a strong institutional client base behind them,” says Lac Vuong, managing director of Effron.

But Morningstar has a distinct advantage – name recognition.

“Morningstar certainly is a brand name,” says Richard Sincere, chief executive of Sincere & Co., a consulting firm in Holliston, Mass., that recently launched Sincere Separate Accounts, a separate-account program aimed at financial advisers.

“If they get into the business, it will simply bring more recognition to everyone.”

And while Morningstar’s would-be competitors tend to focus more on big institutional investors, it caters mainly to retail investors and financial advisers. Whether the separate-account industry will ever grow to rival the $7 trillion mutual fund industry remains to be seen.