by Melissa Klein
After more than 25 years, individually managed accounts may be hitting their stride.
While they’ve historically taken a backseat to widely accessible mutual funds, which have low account minimums, IMAs, also referred to as separately managed accounts, have caught the attention of advisors and the investing public, as evidenced by their explosive growth in recent years.
Mutual funds continue to dwarf IMAs in terms of assets under management - worldwide fund assets topped $10 trillion at the end of the third quarter of 2002, according to the Investment Company Institute - but IMAs are proving to be worthy contenders for investors’ money.
While estimates on the size of the IMA industry vary, industry reports peg it at upwards of $3.6 billion. Boston-based research and consulting firm Cerulli Associates reported that assets held in separately managed accounts as of the third quarter of 2002 totaled $361.7 billion, accounting for more than half of the total managed accounts universe.
For the same quarter, the Money Management Institute, a national organization for the managed account industry based in Washington, estimated that assets held in separately managed accounts industry-wide totaled $392.57 billion, up from $161.01 billion at the end of 1996.
"Managed accounts, today, are where mutual funds were in the 1980s," said Len Reinhart, president of separate account services for the Bank of New York. Reinhart sold his firm, Lockwood Financial, an independent distributor of managed accounts, to BONY last year. "In 1987, there was about $1 trillion invested in mutual funds. Then they just took off. Over the next 13 years, mutual fund assets grew to $7 trillion. Everything is coming together for managed accounts. The pricing is there, the technology is there, and companies are getting into the business."
IMAs are attractive for a number of reasons, the most frequently touted being tax efficiency and customization.
Unlike mutual funds, where investors own shares in a company that owns individual stocks, in separately managed accounts, investors own the individual stocks. Each IMA generates a new cost basis.
"In years past, IMAs were basically upscale mutual funds. They weren’t differentiated that much, but people liked the idea of saying they had a money manager rather than a mutual fund," said Reinhart. "But during the past seven or eight years, technology came into play that allowed IMAs to be truly customized. A lot more wealth was also created and you had a lot more people with a lot more taxable money who wanted their investments fine-tuned. That’s where IMAs are a perfect fit. The concept is nothing magical. They invest in stocks, bonds and cash, but the vehicle allows it to be run on a customized basis."
"Advisors can really impact their clients’ tax situation," said Reinhart. "They can run the account after tax so the client keeps 90 percent of the returns. If they have a lot of capital gains, the advisor can harvest losses to offset the gains."
Improvements in technology and increasing competition have also driven down costs, making the cost of a separately managed account comparable to that of an actively managed mutual fund. Companies that offer IMAs have also overcome pricing objections by unbundling their fees.
"When the costs are broken down, the manufacturing expenses are similar to that of a mutual fund," said Reinhart. "When investors look at the cost of a mutual fund, they’re not looking at the advisor fee. People became more comfortable with the pricing when the companies unbundled it."
"With a no-load equity mutual fund, the average is about 140 basis points for manufacturing expenses, without the advisor charge," said Reinhart. "For the average IMA it’s about 115 basis points, not including the advisor fee."
And, unlike a mutual fund, where the fee stays the same no matter how much money is in the account, with a separately managed account, the larger the account, the lower the fee.
"The cost is similar to that of an actively managed retail mutual fund - around 1 percent, not including the advisor fee. And they offer a lot of added value that don’t you get in mutual funds - flexibility, individuality," said Joel Framson, CPA/PFS, CFP, of Glowacki Framson Financial Advisors, in Los Angeles. And unlike mutual funds, IMAs may be funded with low basis stock.
Framson’s firm, which has an average client account size of about $2 million in total investable assets, has been using IMAs for about five years. At least half of the firm’s clients are in IMAs.
As with most investment options today, advisors setting up IMAs for their clients have the option to do it themselves - researching and hiring money managers and doing the back office work on their own. Or they can use a turnkey platform, where a sponsor firm takes care of the research and back office, while the advisor deals with the client.
"We found we were better off using a separate account platform to do the research and due diligence on managers and the back office work - the stuff that was time consuming. It’s a reasonable price to pay for research on money managers and to have a lot of the back office done for you," said Framson.
In addition to customization and pricing economies of scale, IMAs offer a see-through capability that mutual funds can’t match. "You can see what the account is holding as of yesterday," said Reinhart. "With a mutual fund, you only see what the account is holding when you get a statement."
However, IMAs aren’t a good fit for all clients. While mutual funds have low account minimums, making them ideal for smaller investors, managers of individually managed accounts typically have a minimum account size of $100,000. While some money managers now offer IMAs with account minimums as low as $50,000, they are the exception rather than the norm, according to Reinhart. And, in order to achieve diversification, clients need to have more than the account minimum.
So how much money does a client need before an IMA is appropriate? That depends on who you ask. Reinhart’s threshold for using an IMA is $300,000 or more in taxable investable assets, while Framson’s rule of thumb is $1 million in investable assets.
In terms of the information and performance records available and ease of administration, mutual funds still have the upper hand. "Managed accounts are harder administratively," Reinhart said. "It’s easy to buy a mutual fund. With a managed account, you have to open a brokerage account and there’s more paper involved."
"It’s more work," said Framson. "There’s more research that the advisor has to be familiar with." And, he noted, "It’s not as easy to rebalance and move money around between managers if you want to rebalance the portfolio at the end of the year."
"With mutual funds, you can easily shift money from one category to another. It’s a little more difficult with separate accounts," he said. "Generally, everything has to be sent to the client for a signature. And because of the account minimums, it’s more challenging. You can’t take money out of an account if it leaves the amount too small to meet the minimum."
