Do multi-sleeve accounts live up to the promises their sponsors are making?. Ronald Surz is president of PPCA, a San Clemente, Calif.-based software firm that provides performance-evaluation and attribution analytics, and a principal of RCG Capital Partners, a Denver, Colo.-based fund-of-hedge-funds manager.

I wrote the bulk of this article in June 2002. A lot about multiple-style portfolios (MSPs) -- also called "multiple-strategy portfolios" and "multiple-discipline accounts" -- has changed since then, but they still benefit sponsors more than clients.

In sum, we've become much more efficient at doing a mediocre job -- and "mediocre" might be putting it kindly. When I first wrote these comments there were only a few flavors of MSPs, but these have proliferated into the likes of "model portfolios" and "unified managed accounts."

So here's a little slice of the past offering the observation that, then and now, what sells doesn't work. As you'll see, clients could benefit from these programs if we'd work a little harder at fulfilling our promises rather than filling our wallets. And who knows, working harder to fulfill the promise of MSPs and other multi-sleeve fee accounts could turn out to be good for business.

Skill

MSPs are becoming the rage for small investors. Broker sponsors package families of separate account managers, with various investment styles, into diversified investment programs. According to the hype, MSPs give you the skill, diversification and tax awareness that the big guys get. Let's examine each of these three benefits more closely.

Skill is important to the client because it should add value beyond the additional fees the client pays for active management. In a multi-style program, this skill should be evidenced as return above an index fund, or, for taxable investors, return above an index ETF. Since MSP programs employ active managers rather than index funds, sponsors of these programs are telling their clients, explicitly or not, that they are expert in identifying managers with skill.

But do these sponsors really know how to find skillful managers?

Clients should be skeptical of this claim for a couple of reasons. First, the list of managers being considered for MSPs is the same list employed in wrap programs. These managers are predominantly retail oriented, which doesn't make them good or bad, but does make the list very short. If the client is really going to get best-of-breed, the search for talent ought to extend to institutional managers. Who knows? Maybe some institutional managers are more talented than their retail counterparts. In addition, most sponsors search for manager talent with tools that were developed in the 1980s, before we understood the importance of style, and recognized the serious problem of confusing style with skill. So the promise of delivering skill to the client is unreliable.

The future may tell us the real story here. But then again, maybe it won't: the sponsor is the evaluator, after all.

Diversification

This one's like motherhood and apple pie. It's a must-have because it's expected to give the client the best return for the risk beng taken. In MSPs diversification is controlled by the sponsor, who conscientiously allocates among managers with different styles, with the goal of maintaining both style and security diversification.

The client should understand the mechanics of these allocation decisions. For example, if a growth manager and a value manager are used, does each receive half the assets? If the growth manager has some value stocks in that portfolio, are any adjustments made? How do you monitor style purity and control overall portfolio diversification? In practice, the sponsor sees the model portfolios of all of the managers in the program, and has the opportunity to decide how close to come to each model for each client. The sponsor has trading technology to help him make these decisions, but this technology generally doesn't incorporate style.

If the sponsor is monitoring style at all, there's a good chance it's being monitored with returns-based style analysis (RBSA).

RBSA can't determine the style composition of a portfolio at a point in time: it can only estimate the mix of styles that the portfolio has behaved like in the past, which is not very helpful to making allocation decisions at a point in time.

Trading technology can control sector diversification, since sectors are something we understood in the 1980s, whereas the importance of style is a relatively new revelation. But much of the technology in use today has not adapted to what we've learned recently about the importance of investment style.

Tax awareness

This is the third stated benefit of MSPs. It's a stated benefit of most investment programs for taxable investors. Does anyone know if this awareness actually is delivering superior after-tax returns?

We could be measuring and evaluating this, but we're not. Part of the reason is the complexity involved. Investments and taxes are both very complex. Put them together and you've got a mess. Now take this complexity for a simple single account and extend it across the hundreds of accounts in an MSP program, each account with its own unique tax situation, and you've got chaos.

"Tax aware" is a neat thing to say, but not very practical, especially in an MSP. Remember: clients have the alternative of using tax-efficient instruments that work, like ETFs.

So here's the point. Some of these MSP trains that are rushing to leave the station are destined to derail. With a lot more thought and careful preparation, departures might be delayed, but it might mean that the trains, and their passengers, will reach their destinations safely.

That would be a win-win, right? -FWR

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