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So much for traditional outsourcing

Thomas Coyle

19 September 2005

Bank says in-house control is vital to broader adoption of SMAs. Compass Bank recently finished converting its equity investment platform to Smartleaf’s Portfolio Manager overlay software. The Birmingham, Ala.-based regional says the installation helps it sidestep traditional SMA providers in favor of an in-house approach to “second-generation” unified managed accounts (UMAs), characterized by lower administration costs, more control over investment processes, custody neutrality and enhanced customization for the end client.

“ came to us with the specific intention of putting an open-architecture separately managed account (SMA) platform in place,” says Sam White, director of business development at Cambridge, Mass.-based Smartleaf. “But they quickly realized that our system could take them way beyond SMAs.”

In common with many others in the investment arena, White uses the term “open architecture” to mean a combination of third-party investment products and proprietary offerings. Others, however, refer to that as “enhanced” or “hybrid” architecture, reserving the “open” designation for platforms with no proprietary offerings at all.

What it takes 

Hybrid architecture is becoming the approach of choice for banks that “understand what it takes to compete in the space,” says Dan Seivert, managing principal of 3C Financial Partners, a Los Angeles-based investment bank and consulting firm. “Hybrid platform architecture is not entirely reliant upon the products and services of a third party, and it has the ability to offer a greater breadth of products and services than a proprietary solution.”

And that’s essentially what Compass was after. “We had been organized as a traditional trust with a proprietary focus on a large-cap core product, fixed income and individually managed securities,” says Todd Smurl, head of portfolio management in the bank’s wealth-management department. But then about two years ago Compass decided to broaden its investment platform by putting outside managers on an SMA platform.

But in its search for an approach to SMAs in keeping with its wealth-management style, Compass says it found many of the industry’s outsourced offerings to be decrepit, over-priced and substandard. Given Compass’ experience in vetting some of the SMA industry’s mainstay vendors, Smurl says it’s little wonder the product accounts for less than 1% of the $4 trillion in high-net-worth assets that he says are overseen by chartered financial analysts.

For all that, Compass was determined to make hybrid architecture – though it too calls it “open” – the centerpiece of its wealth-management platform. And it isn’t the only bank to have hit on SMAs as a way to compete for private-client assets. The Money Management Institute (MMI), a Washington-based industry association of SMA managers and sponsors, says that banks – including private banks and trust companies – added SMA assets more rapidly than any other financial-service category in 2004.

That sounds impressive, but it masks a stark fact: banks are hemorrhaging high-net-worth assets. Seivert reckons that North American private banks saw their share of high-net-worth investors’ professionally managed assets decline from around 86% in 1995 to 38% percent at the end of 2004. By 2010, he adds, private banks could be managing just 29% of those assets in North America.

Such losses appear in sharp relief against a backdrop of rising high-net-worth assets. The total wealth of individuals and families around the world with at least $1 million invested went from $14 trillion in 1995 to about $31 trillion at the end of 2004, according to Seivert. By the end of the decade, he adds, high-net-worth assets could reach $44 trillion, with North America’s wealthy accounting for a good third of that total.

Fighting back

The main beneficiaries of the bank channel’s failure to keep high-net-worth assets have been the big brokerage houses and other competitors that have either made product and platform enhancements or offer more personalized service to help them compete for wallet share. SMA assets, including those in multiple-discipline accounts (MDAs) and UMAs, had grown to $576 billion by the end of 2004, up nearly 16% from year-end 2003, says the MMI. And though the industry group expects to see them hit the $1.3-trillion mark by 2009, with non-wirehouses gaining market share along the way, the bulk of those assets – now at around 80% – will likely remain with big-name brokers.

Proponents say SMAs work for well-to-do clients because they combine “investment planning, policy development, manager search and selection, portfolio management, performance measurement and trade execution” for a single fee, as the MMI puts it on its website. The industry group adds that SMAs can also be customized “to reach specific financial objectives” and to lessen the impact of taxes.

But with minimums that typically range from $100,000 to $1 million per account, it can be costly to achieve adequate diversification using traditional, single-sleeve SMAs.

That’s where MDAs and UMAs come in. MDAs are managed accounts that hold different styles of a single security class, generally equity. UMAs can include equity styles as well as other asset classes and investment vehicles: fixed income, alternatives, mutual funds, exchange-traded funds – in short, just about anything that can be crammed into a single-registration account. And for the most part MDAs and UMAs have lower hurdles than the aggregate minimums for comparably diversified portfolios of stand-alone SMAs.

Like many other regional players keen to upgrade their investment offerings to compete with national wirehouses and local boutiques, Compass turned to outsourcers to help it get an SMA platform up and running. It found, however, that many of the third-party platform providers simply couldn’t give it what it wanted .

“We were unimpressed by the third-party vendors out there,” says Smurl. Specifically, Compass wasn’t keen on “broker-oriented” programs and connectivity providers that Smurl says bundle services the bank didn’t want or need.

For one thing, Smurl and his colleagues thought they could do some of those things better in house. In addition – and perhaps more pressingly – they had a mandate from their bosses to “maintain the profit margins of a trust” even as they brought in outside managers and introduced more sophisticated products. Profit margins in bank trust departments are generally fatter than those of wirehouses, according to Smurl.

Compass wanted access to outside managers and a trade-management system, but, along with keeping costs to a minimum, it was determined to control the entire investment process, keep custody of its clients’ assets and be able to offer closer customization than anything an all-in-one third-party could provide.

Points of contention

“Partly because of their creation by wirehouse brokerage firms with a traditional mass-affluent clientele, and partly because of the antiquated technology that underlies the majority of the platforms that exist today, the cost to a wealth-management firm for for wealth-management firms looking to implement separate-account platforms for their clients” – and that, he says in his letter, opens up “new frontiers in investment management.”

Compass has more than 380 branches in Alabama, Arizona, Colorado, Florida, New Mexico and Texas. Its Houston-based wealth unit manages assets of about $4 billion. –FWR

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