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Separate Account Management—Tailoring Solutions for Each Client’s Needs

Industry experts say that separate account management can be the best alternative for precisely meeting the needs of clients with high levels of investable assets—particularly those with concentrated holdings or those who place a high priority on tax-smart investing. This article, researched and prepared by Standard & Poor’s, provides you with an overview of separate accounts and includes the perspectives of three advisors who have successfully integrated separate account management into their practices.

Separately managed accounts, portfolios of individual securities managed by institutional-caliber money managers, have become an increasingly popular vehicle for asset management. Assets in separate accounts totaled approximately $321 billion on December 31, 1998—up 40% in one year, according to statistics released this past May by the Money Management Institute.

Advisors who incorporate separate accounts into their practices report they can be especially useful for attracting clients that their practices would not otherwise be able to serve and retaining clients whose needs increase in sophistication. They also say that separate account clients typically make up a disproportionately large share of their practices’ assets under management.

Making the Case to a Client or - Prospect
Tax efficiency may be the most compelling argument in favor of separate accounts, say experts in the field. "Mutual fund turnover ratios have grown to an average of about 100% per year, from 10% to 12% per year, because many mutual fund managers trade aggressively to get every last basis point," said Len Reinhardt, Chief Executive Officer of Lockwood Associates and a leading industry advocate for the use of separately managed accounts.

As a result, even buy-and-hold mutual fund investors can face yearly tax liabilities. They must also forgo the use of loss-harvesting strategies that investors in individual securities can use to reduce capital gains taxes. Separate account managers, by contrast, can time a client’s trades for optimal tax treatment based on the individual’s specific needs.

Other valuable characteristics of separate accounts cited by advisors include:

• Accommodating concentrated holdings. The manager of a separate account can efficiently direct the liquidation of a large holding or construct a portfolio that diversifies its risks.
  
  
• Providing select clients with the cachet of direct discussions with institutional money managers. "Some high-net-worth clients want to feel that they have something that distinguishes them from ordinary investors in mutual funds," said one advisor who uses separate accounts.

A potential disadvantage of separate accounts for some clients is the longer lead time it may take to create or sell a portfolio. Advisors should, therefore, be certain that the prospective separate account client is comfortable with that relative lack of liquidity.

On a pre-tax basis, performance may not be a distinguishing characteristic when presenting mutual funds and separate accounts to clients. "When style differences are accounted for, we have found no evidence that there is any return advantage for the separate account manager form of investing compared with mutual fund investing," said one advisor.

Separate accounts should be seen as one tool in a wider array. "We’re not moving a specific product," said one advisor. "We are implementing a strategic asset allocation, and our choice of recommended vehicles—managed accounts, mutual funds and other products—will depend on the client’s comfort level with passive and active investment styles, level of investable assets and long-term goals."

Discussing the Costs of Separate Accounts With Clients
The total cost of a separately managed account and mutual fund portfolio may appear to be similar, but the fee arrangements and presentations are different. For example, an investor in a typical separate account arrangement normally receives statements itemizing all fees for asset management and the brokerage expenses involved in each trade.

A mutual fund investor, by contrast, routinely receives standardized financial presentations that focus on bottom-line expense ratios and net asset value calculations. The mutual fund expense ratio may be roughly analogous to the separate account management fees; however, it does not include a mutual fund’s actual trading costs, which are only formally disclosed in its Statement of Additional Information, not in its prospectus or semiannual reports. Net asset value calculations are based on purchases and sales reported net of brokerage commissions, thus mutual fund trading costs are embedded in total return calculations, not listed separately as in separate account statements.

Without a fully loaded cost comparison, it may appear that separate account management is more costly. Some practices use standardized fund analyses to help clarify the full cost of mutual fund alternatives for their clients. "We do a Morningstar Principia printout for the mutual fund portfolio that we’ve recommended, which identifies the total expenses of the portfolio, then use that to compare it to the separately managed account alternatives," noted one advisor.

Positioning Separate Accounts in Your Practice
Advisors using separate account managers often position their own role as that of the architect. "We explain that our role is to construct the portfolio and select the best separate account managers," said one advisor. "Then we work with those managers to meet the client’s financial goals."

Positioning yourself as the investor’s objective agent can be especially useful when you are being compared to wrap brokers. "I point out that brokers’ range of choices can be limited, and their products can be driven more by commissions," one advisor noted. "I also remind potential clients that we offer a range of unbiased professional services unavailable from ordinary brokers—including tax preparation, estate planning and investment consulting, as well as discretionary investment management."

Separate Account Options at Schwab Institutional
Schwab Institutional has long provided support services to advisors establishing or managing a separate account framework. Advisors can initiate their own separate account management frameworks:

• Directly, using our Managed Account Connection™ list, featuring separate account managers who are committed to working with advisors and who have lowered their account minimums and management fees for firms working with Schwab Institutional;
  
  
• Directly, through arrangements negotiated independently between advisors and the separate account managers;
  
  
• And through Registered Investment Advisor Consultants who provide assistance with manager selection, ongoing due diligence and performance reporting.

This article and opinions therein are for general information only, and are not intended to provide specific advice or recommendations for any individual or situation.