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Scandals Drive Investors To Private Managers

Jeff D. Opdyke, The Wall Street Journal

December 10, 2003

With all the controversy swirling around the mutual-fund industry these days, investors might wish they could build their own fund.

Betsy Nichol did just that.

The 53-year-old New Yorker in September moved $200,000 into a separately managed account, abandoning the mutual funds she once owned. Now, instead of wondering what portfolio managers are doing inside her funds, she knows exactly when trades are made, is aware of every stock she owns and gets a weekly e-mail updating her about her investments. Even better, says Ms. Nichol, owner of a marketing and communications firm, "I can call and talk to the manager whenever I have questions."

As Wall Street continues to rebound from the worst bear market in a generation, a new breed of investors -- the so-called mass affluent -- are demanding and receiving the personalized and customized attention that portfolio managers once lavished on high-dollar clients. For a fee similar to what many mutual funds charge, ordinary investors with as little as $25,000 can now play in a league where the price of entry once was $1 million or more.

Separate accounts are basically individual investment accounts overseen by a professional money manager who typically handles several dozen clients. The money typically is invested in individual stocks and bonds. While money managers often put numerous clients into similar investments, they also customize the portfolios for each client. Unlike a mutual fund, investors still have ultimate say over what is or what isn't in an account. Investors can also determine when profits and losses are recognized, which gives them greater flexibility when tax time rolls around.

Fees can be high. Investors opening accounts directly through a money manager typically pay 1% of assets under management annually plus trading costs. They can steer the trading to a discount brokerage firm to save money.

Investors buying through a financial adviser typically pay 1% of assets to the adviser. On top of that, they pay the money manager anywhere between 1.5% and 3% generally. That includes trading costs.

It's not just the allure of personalized attention giving a boost to these accounts. Investors have been spooked by a rash of scandals on Wall Street, the latest being the disclosures that mutual-fund executives allowed speculators -- and even their own employees -- to make market-timing trades at the expense of long-term investors. The mutual-fund scandal was "the turning point," says Ms. Nichol. "I pulled out my money and went to a separately managed account.

In total, such accounts today hold nearly $460 billion in investor assets, roughly three times their $161 billion in assets in 1996, according to the Money Management Institute, a Washington trade group. That's only a fraction of the $4.3 trillion invested in mutual funds (not counting money-market funds). But separate account assets have grown at nearly 17% a year since 1996; mutual funds have grown at an annual pace of about 9%. At Lord Abbett, separately managed accounts have grown to about $16 billion from a bit less than $4 billion in 1999.

Investments minimums for separately managed accounts typically begin at $100,000 or $250,000, but sometimes go much higher -- and occasionally go much lower. Christopher L. Davis, executive director at the Money Management Institute, says even though the entry level has fallen drastically in recent years, "these accounts really aren't appropriate unless an investor puts up about $300,000, otherwise you don't get meaningful portfolio diversification."

James Vitalie, executive vice president at Curian Capital, in Denver, disagrees. Curian in March launched a fully diversified separately managed account for a minimum investment of just $25,000. The firm has created a software program that allows it to mimic the portfolios of money managers who otherwise require investment minimums as high as $10 million. Many of the investments are just a fraction of a share.

Buy-and-hold investors who don't need much hand-holding from an investment pro won't find much value in a separately managed account since it's cheaper to trade on their own.

Still, for investors who want professional guidance, separately managed accounts offer some advantages over a basket of mutual funds. For starters, the accounts are built around a single investor -- you -- not a horde of investors. Investors are paired with their own portfolio manager; each T. Rowe Price manager, for instance, works with just 40 or so clients. (The Baltimore investment firm requires a minimum stake of $2 million to open such an account.)

And while different investors' portfolios may resemble one another in their core holdings, the accounts allow for a level of customization that mutual funds simply can't offer. If you work for a pharmaceutical company, for example, and own a lot of company stock in your 401(k) plan, your portfolio manager can purposefully avoid the drug industry so that you're not overexposed to the sector. Mutual funds won't do that.

Like mutual funds, separately managed accounts come in dozens of flavors, from fixed income to small-gap value. Each account holds anywhere from a couple dozen securities to several hundred, depending on style and size. Some are overseen by a single manager; others are divided between several managers.

Unlike mutual funds, separately managed accounts are entirely transparent. Ms. Nichol, the New York investor, receives confirmation of every trade made in her account, and she knows the stocks she owns. Mutual funds, by comparison, typically report their holdings once a quarter, and that information is often stale.

There are two main avenues into a separately managed accounts: through a financial adviser, or directly through a money-management firm. For instance, Smith Barney Consulting Group clients go through a Smith Barney adviser and pick from a stable of separate account managers; some are Smith Barney managers; others are outside managers who have been vetted by the firm. With New York's M&R Capital or T. Rowe Price, by contrast, clients more often open accounts directly through the firm, which actually manages the money in-house.

Performance inside separately managed accounts is all over the map, and varies with investment style. An all-inclusive index of separately managed accounts was up 5.44% a year on average in the past five years, according to data from Effron-PSN. The Standard & Poor's 500-stock index over the same period was up 1% a year.

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How They Stack Up

Once the province of the wealthy, separately managed accounts are now availaable with minimums of as little as $25,000.

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