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Delivering ‘sleep-at-night’ SMA strategies for 30 years
by Alex Steger, EDITOR - CITYWIRE US
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One of asset management’s sleepiest corners might be fast becoming its most exciting. Separately managed accounts (SMAs) are not new and, historically, they have been clunky and unavailable to all but the wealthiest of clients. But that’s changing thanks to myriad factors, not least technology. The vehicle is now poised for a period of growth, thanks largely to its ability to manage taxes, offer personalized strategies, and at lower fees and minimums than ever before. In chapter one, we explore how SMAs have gone from being the preserve of the super-rich, used by a few advisors, to something approaching the mainstream. The vehicle’s change in popularity is partly down to wider industry trends such as the rise of the fiduciary movement, but also enhancements in the way these strategies can be managed, particularly at scale. In chapters two and three, we hear from the two sides of the industry, the buyers and sellers. In chapter two, we look at what some of the most influential gatekeepers are doing with their SMA programs and why, while chapter three is all about how asset managers see the space, and where they are innovating to stay ahead of the field. I hope you find it useful.
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Cargo pants, the joke goes, never go out of fashion – because, of course, they have never been in fashion. The same is broadly true for Separately Managed Accounts (SMAs). Dating back to the 1970s, the vehicle has long had its champions, who recognize its quiet practicality and prefer it to the brashness of mutual funds or the hi-tech pizzazz of ETFs. Yet the vehicle has never quite gone mainstream. But just as normcore hipsters co-opted the cargo pant and made it unironically cool for the first time since… well, ever, SMAs are also finally having their moment. At the end of 2019, there was $1.2tn in manager-traded or proprietary SMAs at the major wirehouses and broker-dealers, up 22.2% from the year before, according to Cerulli Associates. While some of this increase is clearly down to market appreciation, it is fair to say that both the wires and asset managers are placing a heavy focus on their SMA propositions. Fidelity Investments is among them, with the mutual fund giant launching a range of SMAs for advisors on a series of wirehouse and broker-dealer platforms for the first time at the end of last year. The firm’s move reflected the growing importance of the vehicle at wirehouses and broker-dealers that are expanding their offerings, and there is increased use by the ever-growing RIA market too. At the time of the Fidelity SMA launches, Bob Litle, the firm’s head of intermediary sales, told InvestmentNews that the company was responding to advisor interest, that it wanted its active strategies available in multiple vehicles and that, ‘Demand for SMAs has seen a big uptick the last couple of years.’ A 2019 Cerulli survey of financial advisors further emphasizes this point. Advisors said they planned to trim their mutual fund use by an average of 12%, while upping their use of ETFs and SMAs by 20% and 19%, respectively. ‘It’s almost like a renaissance,’ said Tom O’Shea, director of managed accounts at Cerulli. ‘This is the sort of cornerstone product that’s been around since the 1970s. People think it’s fuddy-duddy. It’s old. But really, what’s happening is technology is offering opportunities to look at that product afresh.’ Greg Weiss, BlackRock’s head of managed accounts, agreed that the SMA was very much in vogue and that technology was a key driver for this. ‘This trend of outsourcing using SMAs and also models is resurging in the marketplace,’ Weiss said. ‘And a lot of the reason why is that SMAs are no longer just for the wealthy. Unified managed account (UMA) platform technology has democratized access to SMAs, and now they’re accessible to massive flows and mass consumers and across all channels: RIAs, indies, wires and direct. ’While technology is one reason for the growth of SMAs recently, it is a trend that is also driven by a number of overlapping factors, including the shift from brokerage to advisory, the Department of Labor’s fiduciary rule and an increased focus on tax management.
Rise of advisory The megatrend driving the growth of all managed account programs, and within that, SMAs, is the industry-wide move away from a commission-based brokerage model and toward a fee-based advisory one. According to Weiss, advisory assets now account for around 50% of the wealth management industry, up from less than a third. ‘The big trend here is the move away from advisors constructing portfolios of individual investments,’ O’Shea said. This trend has seen advisors move from being portfolio managers – picking stocks and bonds and building portfolios – to outsourcing all or part of this process to third-party asset managers. Advisors may still build the portfolio, but they use mutual funds, ETFs or SMAs from asset managers. They may go further and use model portfolios run by home offices or asset managers, again made up of mutual funds, ETFs and SMAs. Craig Pfeiffer, president and CEO of the Money Management Institute, said the shift to advisory was driven by the tasks of creating financial plans and managing money becoming too complicated and time-consuming for one person to do them both well. ‘Over the last number of years, the advisor’s conversation with the client [has changed],’ Pfeiffer said. ‘What used to be “you’ve got money, let’s invest it” is now about all of these life-related, financial-related issues. And so, advisors started to get more engaged in financial planning… [and] the time that that was taking… was interfering, if you will, in the original advisor investing the money. ‘Meanwhile, over on the investing side, it became far more complicated and sophisticated,’ he added. ‘At the very root of all this was what clients needed in advice and what advisors were able to do. Advisors found a quick solution to capacity by using professional money managers. ’The rise of advisory is not just taking place within wirehouses. It is both a cause and an effect of the RIA movement, which has grown as brokers fled wirehouses in a bid to be fiduciaries and independent. RIAs too are increasingly using SMAs. This is partly because they had them at wirehouses. According to BlackRock’s Weiss, nine out of 10 wirehouse advisors use SMAs. So when they leave, it is not a surprise that they want to continue offering these vehicles to clients. He said that this had resulted in BlackRock seeing a compound growth rate of 20% in SMAs at RIAs and the wirehouse market share of the retail SMA market falling to 56% from 75% a decade ago.
DOL lives The shift towards advisory was well in motion by the time the Department of Labor (DOL) proposed its fiduciary rule in 2015. It may never have come into force, but it still accelerated the move away from brokerage business and, as part of that, the growth of SMAs. The rule would have required broker-dealers managing retirement accounts to act in their clients’ best financial interest, holding them to a fiduciary standard generally reserved for Securities and Exchange Commission-registered investment advisors. This would have stopped brokers recommending investments that charged higher fees when a cheaper product was available or that paid the broker a commission but at a greater cost to the client.
Despite the rule never seeing the full light of day – it was officially vacated in June 2018 – it had a huge effect on the wealth management landscape with large wirehouses, which control around 50% of retail assets, according to Cerulli’s O’Shea, rushing to move money from brokerage to advisory in a bid to have greater control over investment decisions and not fall foul of the new measures. ‘The DOL was both the cause and effect,’ O’Shea said. ‘It was an effect in the sense that it was the combination of a long-term trend towards fiduciary relationships and the government coming to realize that the brokerage model was fraught with conflicts of interest. ‘Even though the rule was vacated, the industry spent a good two years retooling itself to be able to manage retirement accounts under that regimen. So… it had the effect it was supposed to have. ’As part of their preparation for the DOL rule, firms moved to improve their advisory programs, leading to a greater emphasis on home-office-run discretionary model portfolios and the growth of UMAs. UMAs allow the home office and advisors to build portfolios using a combination of mutual funds, ETFs and SMAs and view these holdings in one place. This latter trend was made possible by technological advances, which we will look at in more detail shortly. ‘When it was just SMA only, you couldn’t see the whole. Now, in a UMA, you have the ability to see that consolidation,’ Pfeiffer said. According to research from Cerulli, at the end of 2019, there was $993bn in discretionary UMA programs at the major wirehouses and broker-dealers, a figure that had grown 43.4% on the previous year – the highest growth rate of any managed account program. Non-discretionary UMA programs had $374.7bn in assets, up 25.9% from the previous year. While money within UMAs can sit in mutual funds and ETFs too, their growth in popularity is a boon for SMAs. Of the $1.4tn in discretionary and non-discretionary UMAs, 40.2% – or $550bn – was in SMAs, with 36.8% in the next most popular vehicles, mutual funds, according to an April Cerulli report covering the fourth quarter of 2019. ‘UMAs continue to take over the advisory landscape, driving more and more sponsors to demand SMAs in a model-delivered format,’ the report says. As part of preparations for the DOL rule, all wirehouses launched platform rationalization plans, culling high-cost and underperforming mutual funds, and raised the barriers significantly higher for new funds hoping to secure shelf space. According to the Cerulli report, this has pushed asset managers that typically only offered funds, such as Fidelity, to begin offering SMAs too. ‘Cerulli sees this [SMA] offering as a way to counter platform rationalization,’ it says. ‘By offering its strategies in a variety of vehicles and wrappers, Fidelity stands a better chance of deepening its relationships with distribution partners and remaining on shrinking platforms, and they are not alone in pursuing this strategy. ’The report mentions that Putnam Investments, American Century, Aberdeen Standard Investments and Ivy Investments have made similar moves. The shift to advisory and the use of SMAs made sense for wirehouses from a business perspective too. Brokerage revenue is episodic, whereas advisory is recurring. The former was also fast becoming a low-margin business as technology allowed consumer-facing brokers such as Charles Schwab to lower prices, forcing the rest of the industry to follow. Within advisory programs, SMAs have allowed wirehouses to lower costs for clients without having to drop their own wealth management fees. The vehicles are often as much as 40bps cheaper than a mutual fund running the same strategy, according to one asset management executive, who asked not to be named. ‘They [wirehouses] are trying to reduce the cost of the portfolio to the client, by reducing the cost of the asset manager,’ O’Shea said. ‘And actively managed mutual funds are expensive products. If you have an expense ratio north of 60 or 70 basis points versus a model-delivered separate account of 28 basis points. That’s a big difference.’
Weiss said: ‘Model delivery technology has just knocked down barriers to entry. It’s creating the opportunity for more overlay technology providers, as well as new entrants and re-entrants. It’s so much easier to enter into the SMA marketplace today than it was a few years ago. ’Other technological advances aid the way the SMAs’ underlying strategies can be managed, particularly how asset managers can offer customized strategies, such as tax-advantaged or ESG-based, at scale and thus at a lower price. ‘Big data, the ability to manage huge data sets, is really important because what happens in these algorithmic portfolios is they need to understand all sorts of characteristics about thousands of different securities and run through all sorts of simulations. And that can only be done when there’s a lot of computing power, the ability to store a lot of data in the cloud that can be accessed by really good algorithms,’ O’Shea said. Improved technology and increased scale allow asset managers to tackle another traditional barrier to SMAs: high minimums. As SMAs gain scale within the retail market, in part due to the wider adoption of model delivery, their minimum investments can also be lowered, making them more accessible to a wider audience. Where once asset managers would only run these vehicles for $1m, minimums can now be as low as $50,000. ‘ With the democratization of SMAs… what you’re seeing [is] wirehouses and technology providers driving scale by shifting client assets to one unified account for all investment vehicles. And this is lowering account minimums, making SMAs almost as easy to buy and sell as an ETF or a mutual fund in a client account,’ Weiss said. ‘This technology has knocked down a lot of barriers, and has made it easier for advisors and clients to access SMAs. And as a result, you’re seeing the growth rate of SMAs in UMA at a little over 30% versus your traditional dual contract platforms [at] slightly over 10%.’ Tax matters Technology also now allows asset managers to use algorithms to run tax-efficient portfolios for clients. These often take the form of tax-loss harvesting strategies that sell securities that have fallen in value, replacing them with similar stocks and using the loss from the initial sale to offset any realized gain. These have proven particularly popular with high net worth individuals subject to potentially high state taxes, and even more so in an era of low yields for bonds and scarce alpha for equities. ‘The value that you can now get from tax-optimized portfolios is an incredible amount of alpha, just in terms of reducing your tax bill,’ Weiss said. ‘Tax management is the new alpha that’s driving growth. You see it in terms of flows and assets where muni and equity strategies with tax overlays are some of the most prominent asset gathers in SMAs today. ‘Fixed income represents about 43% of the $1.6tn of SMA AUM, which is up around 10% from 10 years ago, and tax match equities [are] just consistently growing at double digits.’
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Talking tech The decreasing cost of SMAs and the rise in popularity of UMAs are both due to technological advances. One such advance is around what is known as model delivery, where asset managers send over lists of trades for a given strategy and the wirehouse executes these. According to Pfeiffer and O’Shea, this used to be a laborious and time-consuming process. The $550bn of SMA assets in UMAs are in all model-delivered strategies, a figure that has grown 17% from the last quarter of 2018 to the equivalent period in 2019.
Kevin Maeda CIO, Active Index Advisors
FOR FINANCIAL PROFESSIONAL USE ONLY. All investing involves risk, including the risk of loss. Natixis Advisors, L.P. does not provide tax or legal advice. Please consult with a tax or legal professional prior to making any investment decisions. This material is provided for informational purposes only and should not be construed as investment advice. There is no guarantee that objectives stated will be achieved. All securities are subject to risk, including possible loss of principal. Please read the risks associated with each investment prior to investing. Detailed discussions of each investment’s risks are included in Part 2A of each firm’s respective Form ADV. The investments highlighted in this presentation may be subject to certain additional risks. Natixis Advisors, L.P. provides discretionary advisory services through its divisions Active Index Advisors®, Managed Portfolio Advisors® and Natixis Investment Managers Solutions-US. Discretionary advisory services are generally provided with the assistance of model portfolio providers, some of which are affiliates of Natixis Investment Managers.
When investors think of indexing, they typically think of mutual funds or ETFs that provide broad market exposure in a tax-efficient and low-cost manner. As the industry has evolved over time, so too has indexing, moving from tax-efficient one-size-fits-all investments to tax-managed customized solutions, otherwise known as direct indexing. In these portfolios managers purchase a basket of individual securities that closely resemble the exposure and performance of the index they are trying to replicate. Even though direct indexing has been available to institutional investors for decades, the higher minimum account size required to create a custom index portfolio made these types of strategies unattainable for most investors. Alongside the democratization of indexing as an investment methodology, technological advancements and decreased trading costs have now made direct indexing a viable option. With improved accessibility for individual investors through separately managed accounts and lower minimums, these customized strategies provide similar benefits as index funds and ETFs, but with greater control and tax efficiency. Layers of customization Buying individual securities enables the flexibility to tailor portfolios to the unique needs of each client. Accounts can be customized to exclude an individual security, industry or sector, create a factor tilt, or align with a client’s values through an ESG screen. By employing these techniques, investors can maintain diversified exposure while targeting portfolios to specific goals. Meanwhile, advisors can coordinate investment activity across the portfolio to try to avoid unexpected tax outcomes. Active tax loss harvesting By relying on direct indexing to provide core, multi-factor, or ESG exposure, investors can attempt to avoid some of the pitfalls of commingled funds. As investors move in and out of mutual funds or ETFs – or as managers change positions – investors can find themselves with unexpected taxable distributions. Direct indexing with separately managed accounts puts control back in the hands of the advisor and investor so that they can manage taxable events through the use of active tax loss harvesting techniques.
Maria Katsileros VP, Senior Investment Strategist, Natixis Investment Managers
Direct indexing is also distinct from using a model portfolio, and with good reason. For example, while two model portfolios may both have positions in Apple, each portfolio was created at a different time. As a result, the purchase prices for stocks that make up each individual’s portfolio are going to be different. From a tax management perspective, the entry point establishes the cost basis and determines whether the position is at a gain or loss. A robust tax management overlay factors in the cost basis for each position at the tax lot level. Model portfolios don’t allow for that level of tax awareness because they cannot differentiate unrealized gains and losses by account. By constructing a direct index, which is usually made up of a subset of stocks tailored toward a specific outcome, the portfolio manager can incorporate active tax-loss harvesting into the investment process. Such active tax management can control the maximum realized gains specified by an investor, perhaps limiting them to only realized losses. In some cases, there may be net realized losses instead, which can be valuable in offsetting gains outside the portfolio or in future years. This may allow investors to defer taxes on capital gains, and potentially increase after-tax returns. Less taxing transitions Direct indexing can also help portfolios that are in transition. Advisors may have prospects or clients with existing stock portfolios, and the only way to transfer these assets may be to liquidate them. But this could result in a sizable capital gain and a large tax bill. Instead of liquidating the positions, they can be moved into a direct index portfolio and transitioned over time using a capital gains budget that could reduce or defer capital gains completely. This could potentially increase investors’ willingness to bring more assets to their advisor to manage. Greater after-tax return potential Ultimately, direct indexing gives advisors another tool for crafting innovative portfolios that solve for acute needs, be that the desire for investment customization or improved tax management. A direct index strategy can also work alongside existing, traditional components of a portfolio and aid the reallocation process over time. This puts a considerable level of control back in the hands of the advisor and the investor to be able to alter portfolios and try to avoid unexpected taxable distributions. Over time, investors may also realize a higher rate of after-tax returns due to active tax management techniques – allowing them to keep more of what they earn.
Curt Overway President, Portfolio Manager, Managed Portfolio Advisors
FOR FINANCIAL PROFESSIONAL USE ONLY. All investing involves risk, including the risk of loss. 1Operated in the US through Mirova US LLC. Prior to April 1, 2019, Mirova operated through Ostrum US. Natixis Advisors L.P. does not provide tax or legal advice. Please consult with a tax or legal professional prior to making any investment decisions. This material is provided for informational purposes only and should not be construed as investment advice. There is no guarantee that objectives stated will be achieved. All securities are subject to risk, including possible loss of principal. Please read the risks associated with each investment prior to investing. Detailed discussions of each investment’s risks are included in Part 2A of each firm’s respective Form ADV. The investments highlighted in this presentation may be subject to certain additional risks. The above referenced entities are affiliates of Natixis Investment Managers, the holding company of a diverse lineup of specialized investment management and distribution entities worldwide. Their services and the products they manage are not available to all investors in all jurisdictions. Natixis Distribution, L.P. is a limited purpose broker-dealer and the distributor of various registered investment companies for which advisory services provided by affiliates of Natixis Investment Managers.
Separately managed accounts (SMAs) used to be solely the domain of institutional investors. However, as technology has improved and the cost to set up and manage accounts has come down, there are now options for individual investors. The minimum investment to access a separately managed account now typically starts at $100,000. The structure of SMAs has also changed such that multiple investment strategies can be included in a single SMA, rather than having to set up individual accounts for each strategy. This is often referred to as a Unified Managed Account (UMA). As a result of these advancements, individual investors are turning to SMAs to create customized portfolios. The SMA structure also supports robust tax planning, which can be meaningful for certain investor portfolios. As a result, RIAs have started offering SMA solutions to clients as a way of scaling their business while providing more tax-efficient and customized investments. Customization for better goal alignment The rise of new investment approaches, including ESG, thematic investing and factor-based portfolios, has led some RIAs and investors to seek greater customization. ESG-focused investors may wish to screen out certain types of stocks so that the end portfolio is better aligned with their values. Factor-based investors may want to customize individual factor weightings relative to their investment goals. Thematic investors may only be interested in specific subsets of companies within the broader economy. All of these desires put pressure on financial advisors to construct portfolios that contain more than a handful of market-cap-weighted mutual funds and ETFs. Within a separately managed account, investment professionals can create portfolios that reflect the desire for customization and provide a solution to the end investor without a significant increase in overhead. And, as investment fees have decreased and many trading costs move to zero, investors can align their portfolios as they see fit without layering in additional fees. Robust tax management The SMA structure allows for investment overlays that can improve portfolio outcomes for investors, specifically when it comes to tax management. SMAs offer two key tax advantages over commingled vehicles: 1.Clients establish their own cost basis in each of the underlying holdings in an investment strategy. 2.Decision making in each account can be customized based on the client’s tax situation. Placing multiple SMA investment strategies into a single UMA means that investment activity can be coordinated throughout the portfolio, potentially creating even greater tax efficiencies. By contrast, in portfolios of commingled funds, changes to allocations can create taxable events. Using SMAs within a UMA can offer the opportunity to transition those assets in a more thoughtful and tax-aware manner. This can improve the performance of taxable portfolios and may help investors realize their goals faster. Target COVID-19 tax issues The benefits of a tax management overlay have become more pronounced as a result of COVID-19. In the near term, investors can use a tax management overlay to efficiently tax-loss harvest investment positions during periods of volatility, mitigating the taxable impact of capital gains elsewhere in the portfolio. Even if there aren’t gains to offset in 2020, these losses can be carried forward to future years to offset gains realized then. Should tax rates change as a result of federal budget concerns, having robust tax management in place now may help limit the potential negative impact of higher capital gains taxes or elevated tax rates in the future. Against the backdrop of market uncertainty, separately managed accounts can be a solution for investors who are thinking through changes to their portfolio allocations and seeking greater customization and tax efficiency. For advisors, UMAs and SMAs can be convenient ways to address investor demand for customization and tax efficiency without taking on significant operational overhead. Technological improvements and low or no-cost trading make it relatively easy to offer the structure alongside other vehicles.
Sean Kane Managing Director, Natixis Advisors
Multi-Affiliate Model Drives Innovative Solutions Data from a recent Natixis Investment Managers survey of financial professionals suggests a pullback from mutual funds and a move toward separately managed accounts. According to Nick Elward, SVP, Head of Business Development and ETFs at Natixis, it’s not surprising that the SMA space is growing. “The structure has been available at a lower minimum investment since about 2008, and over the past decade it has proved to be a way for investors to build the kind of portfolios they want without some of the constraints you see in the mutual fund and ETF space,” Elward says. He notes that firms like Natixis have been able to provide product innovations through the SMA structure to solve for issues investors have been contending with for decades. This includes unique fixed income and real estate solutions, as well as overlays that can help investors as they spend down retirement savings. “The solutions we’ve brought to market in the SMA space are the result of our conversations with advisors and institutions about where the pain points are,” Elward explains. Trading efficiency and tax management Alongside investment solutions, SMAs support tax management overlays that try to ensure portfolio customization doesn’t result in unexpected tax trade-offs. For advisors or investors with complex portfolio needs, this tax efficiency is paramount. Trading efficiency within these strategies also keeps administrative overhead for advisors at a minimum. Diverse investment strategies Natixis Investment Managers’ multi-affiliate model, which includes more than 20 independent asset managers, is another way the firm has been able to innovate. SMAs appeal to investors and advisors because of their customization potential. Natixis can tap the diverse expertise of its affiliates to provide differentiated products to an SMA and create comprehensive investment solutions. This model also gives advisors access to a broad array of investment strategies without having to source them through multiple providers. For example, REITs strategies from AEW, fixed income and large cap growth from Loomis, Sayles & Co., and distinctive equity strategies from Mirova1 (global sustainable equity), Vaughan Nelson and WCM are all available via Natixis. To learn more about Natixis SMAs visit im.natixis.com
WAH0620U-1210594-1/1
Our expectation is that investors will participate in market appreciation during bull markets and be protected during bear markets compared with investors in portfolios holding more speculative and volatile securities. There is no assurance that these expectations will be realized. “Madison” and/or “Madison Investments” is the unifying tradename of Madison Investment Holdings, Inc., Madison Asset Management, LLC (“MAM”), and Madison Investment Advisors, LLC (“MIA”), which also includes the Madison Scottsdale office. Hansberger Growth Investors, L.P. or “HGI” is an affiliate of “Madison Investments.” MAM, MIA and HGI are registered as investment advisers with the U.S. Securities and Exchange Commission. Madison Funds are distributed by MFD Distributor, LLC. MFD Distributor, LLC is registered with the U.S. Securities and Exchange Commission as a broker-dealer, and is a member firm of the Financial Industry Regulatory Authority. The home office for each firm listed above is 550 Science Drive, Madison, WI 53711. Madison’s toll-free number is 800-767-0300. Any performance data shown represents past performance. Past performance is no guarantee of future results.Non-deposit investment products are not federally insured, involve investment risk, may lose value and are not obligations of, or guaranteed by, any financial institution. Investment returns and principal value will fluctuate. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.
Madison Investments’ ‘participate and protect’ philosophy has as much relevance today as it did 30 years ago when the firm launched separately managed accounts (SMA). Here, we talk to two of the firm’s many veterans, head of US equities Rich Eisinger and head of distribution Steve Carl, who have been with the company for 22 and 17 years respectively, about its proud history as a ‘sleep-at-night’ manager
What potential did you see 30 years ago when you launched your first separately managed account? SC: We opened our first fixed income SMA in 1989 and our first equity SMA in 1991. At the time SMAs were reserved for high-end clients – generally minimums greater than $1m – but there was tremendous appetite at lower levels – in the $100,000 to $250,000 ballpark. We saw a real opportunity for a firm with the right infrastructure to bring SMAs to the masses. Additionally, our partner firms and their advisors were more open to hiring 3rd party professional money managers versus being a stock or bond picker themselves. RE: Most of the financial advisors and brokers at the time were using mutual funds or traditional individual stock portfolios. Part of the potential in giving advisors the ability to customize smaller accounts lay in tax optimization while controlling the cost base. How has the market changed since you entered it? SC: Back in the late 80s and early 90s Madison spent a lot of time educating financial advisors about the benefits of SMAs – what an SMA is and why they should use it. Since then, advisors have really changed their value proposition and moved away from commission to a fee-based model. SMAs have helped bring about that transition. RE: The changes have been to the benefit of the client. Fees have come down. Churning among financial advisors and brokers has come way down. More advisors advocating for buy and hold investing. How has your SMA offering changed over the years? SC: The breadth of our SMA product offering is much larger than it was even 10 years ago. We started with two investments strategies and have since expanded to offer a full suite of asset classes managed by our four distinct teams: U.S. Equity, Fixed Income, Multi-Asset Solutions and International Growth. Most recently we acquired a small cap manager in August of 2019 and continue to be on the lookout for talent that may be a good fit for our organization. While most teams are focused on a single asset class, our multi-asset team offers advisors a one-stop shop for asset allocation strategies within an SMA and/or mutual fund vehicle. In addition, the market has shifted from wrap SMAs to model traded SMAs (i.e. UMAs). We work with more than 30 model trading platforms. Advisors can have full confidence that we know the SMA business from top to bottom. What sets you apart from other providers in the SMA space? SC:There is a lot more competition – the SMA/UMA pie has grown dramatically over the years. You can’t win a match without a great team. Madison investment management teams are nationally recognized for our incredible track record of delivering strong risk-adjusted returns. Every single portfolio manager and analyst is invested in their own strategy. We have always been focused on customer service and transparency – giving advisors access to portfolio managers, the rationale for investment decisions and trades. Years ago, we were mainly asked questions about portfolio managers’ performance; today, there is much more emphasis on compliance and cyber security and operational due diligence. Advisors want to know that not only is our portfolio management team sound, but that the rest of the business is also sound. They want to feel buttoned up and safe. We have continued to invest in this aspect of the business to provide comfort not only to advisors but their clients. RE: We are a 100% employee-owned firm. We don’t have a CIO creating the strategy for others to follow. Our portfolio managers have comparative autonomy and that is an important differentiator. What sort of return profile can investors expect from you? RE: Our mantra is to ‘participate and protect’. That is our brand that has been borne out of how we manage money – in a risk-conscious way. We never forget about risk management and are always aware of what the downside is. We run concentrated portfolios with a high active share – even before it was in vogue to do so. You can’t beat the index if you are the index. SC: We’ve never been a closet index manager. We compete with passive investment strategies, but our correlation with the index tends to be very low so we can be used as a complement to passive funds. Managers tend to offer great upside capture or great downside capture. Of course, every manager wants to deliver both. We have a tremendous track record of providing protection in crisis periods and down periods – whether the tech bubble or financial crisis and most recent crisis. We want to avoid permanent impairment of capital. We’re a sleep-at-night manager for many clients. How do you deliver that downside protection? RE: We have a very disciplined process that’s been cultivated over my 20 plus years on the strategy. First, we undertake rigorous fundamental research to find companies with wide moats and sustainable competitive advantages. These businesses are historically resilient in times of crisis. Second, we pay very close attention to the balance sheet. We don’t want to buy a company with excessive leverage and favor those with debt that’s easily serviced by cashflow. Third, we get to know management teams and their ability to allocate capital; we like to see a track record of wise decision making. And finally, we have a valuation discipline. There has never been a bigger disparity between growth companies and value companies. At some point there will be at least some reversion to the mean. Which areas of the market do you like and are there any you avoid? RE: We want to add value where we can. One example of an area where we are likely not to invest heavily is commodities. We might have an opinion about the economy, but macro factors have never been a big part of the process for us and that’s no different today. We are not going to try to predict where interest rates are going or what the central bank will do. We stick to our knitting and buy all-weather companies that should do well in most economic environments. I’ve always said that mid-caps are the sweet spot of the market. These companies are no longer small-caps – they have established sustainable competitive advantages - but still have a long runway of growth. What are the prospects for Madison and the SMA market? RE: Madison, from an investment perspective, is going to do what we’ve always done. We’ll keep working with platforms and research decision-makers, so they have a full understanding of our portfolios, performance patterns and how to use us. SC: Our SMA business has grown significantly since we’ve entered the market. We have very loyal clients that have been with Madison for years and years – it’s been a fantastic run for us. There’s a renewed emphasis on SMA – we expect to see substantial growth. We’ve never wavered on our commitment to SMA and never will.
Rich Eisinger Head of US Equities Madison Investments
Steve Carl Head of Distribution Madison Investments
What potential did you see 30 years ago when you launched your first separately managed account? SC: We opened our first fixed income SMA in 1989 and our first equity SMA in 1991. At the time SMAs were reserved for high-end clients – generally minimums greater than $1m – but there was tremendous appetite at lower levels – in the $100,000 to $250,000 ballpark. We saw a real opportunity for a firm with the right infrastructure to bring SMAs to the masses. Additionally, our partner firms and their advisors were more open to hiring 3rd party professional money managers versus being a stock or bond picker themselves. RE: Most of the financial advisors and brokers at the time were using mutual funds or traditional individual stock portfolios. Part of the potential in giving advisors the ability to customize smaller accounts lay in tax optimization while controlling the cost base. How has the market changed since you entered it? SC: Back in the late 80s and early 90s Madison spent a lot of time educating financial advisors about the benefits of SMAs – what an SMA is and why they should use it. Since then, advisors have really changed their value proposition and moved away from commission to a fee-based model. SMAs have helped bring about that transition. RE: The changes have been to the benefit of the client. Fees have come down. Churning among financial advisors and brokers has come way down. More advisors advocating for buy and hold investing. How has your SMA offering changed over the years? SC: The breadth of our SMA product offering is much larger than it was even 10 years ago. We started with two investments strategies and have since expanded to offer a full suite of asset classes managed by our four distinct teams: U.S. Equity, Fixed Income, Multi-Asset Solutions and International Growth (bit.ly/Madisonadv). Most recently we acquired a small cap manager in August of 2019 and continue to be on the lookout for talent that may be a good fit for our organization. While most teams are focused on a single asset class, our multi-asset team offers advisors a one-stop shop for asset allocation strategies within an SMA and/or mutual fund vehicle. In addition, the market has shifted from wrap SMAs to model traded SMAs (i.e. UMAs). We work with more than 30 model trading platforms. Advisors can have full confidence that we know the SMA business from top to bottom. What sets you apart from other providers in the SMA space? SC:There is a lot more competition – the SMA/UMA pie has grown dramatically over the years. You can’t win a match without a great team. Madison investment management teams are nationally recognized for our incredible track record of delivering strong risk-adjusted returns. Every single portfolio manager and analyst is invested in their own strategy. We have always been focused on customer service and transparency – giving advisors access to portfolio managers, the rationale for investment decisions and trades. Years ago, we were mainly asked questions about portfolio managers’ performance; today, there is much more emphasis on compliance and cyber security and operational due diligence. Advisors want to know that not only is our portfolio management team sound, but that the rest of the business is also sound. They want to feel buttoned up and safe. We have continued to invest in this aspect of the business to provide comfort not only to advisors but their clients. RE: We are a 100% employee-owned firm. We don’t have a CIO creating the strategy for others to follow. Our portfolio managers have comparative autonomy and that is an important differentiator. What sort of return profile can investors expect from you? RE: Our mantra is to ‘participate and protect’. That is our brand that has been borne out of how we manage money – in a risk-conscious way. We never forget about risk management and are always aware of what the downside is. We run concentrated portfolios with a high active share – even before it was in vogue to do so. You can’t beat the index if you are the index. SC: We’ve never been a closet index manager. We compete with passive investment strategies, but our correlation with the index tends to be very low so we can be used as a complement to passive funds. Managers tend to offer great upside capture or great downside capture. Of course, every manager wants to deliver both. We have a tremendous track record of providing protection in crisis periods and down periods – whether the tech bubble or financial crisis and most recent crisis. We want to avoid permanent impairment of capital. We’re a sleep-at-night manager for many clients. How do you deliver that downside protection? RE: We have a very disciplined process that’s been cultivated over my 20 plus years on the strategy. First, we undertake rigorous fundamental research to find companies with wide moats and sustainable competitive advantages. These businesses are historically resilient in times of crisis. Second, we pay very close attention to the balance sheet. We don’t want to buy a company with excessive leverage and favor those with debt that’s easily serviced by cashflow. Third, we get to know management teams and their ability to allocate capital; we like to see a track record of wise decision making. And finally, we have a valuation discipline. There has never been a bigger disparity between growth companies and value companies. At some point there will be at least some reversion to the mean. Which areas of the market do you like and are there any you avoid? RE: We want to add value where we can. One example of an area where we are likely not to invest heavily is commodities. We might have an opinion about the economy, but macro factors have never been a big part of the process for us and that’s no different today. We are not going to try to predict where interest rates are going or what the central bank will do. We stick to our knitting and buy all-weather companies that should do well in most economic environments. I’ve always said that mid-caps are the sweet spot of the market. These companies are no longer small-caps – they have established sustainable competitive advantages - but still have a long runway of growth. What are the prospects for Madison and the SMA market? RE: Madison, from an investment perspective, is going to do what we’ve always done. We’ll keep working with platforms and research decision-makers, so they have a full understanding of our portfolios, performance patterns and how to use us. SC: Our SMA business has grown significantly since we’ve entered the market. We have very loyal clients that have been with Madison for years and years – it’s been a fantastic run for us. There’s a renewed emphasis on SMA – we expect to see substantial growth. We’ve never wavered on our commitment to SMA and never will.
SMAs may occupy a relatively small bit of real estate in gatekeepers’ model portfolios and recommended lists, but the vehicle is poised to take up more shelf space in the near term. The managed account industry had assets of $7.4tn at the end of 2019, of which $1.2tn sat in either single contract, dual contract or proprietary SMAs, with a further $550bn in model-delivered SMAs within UMAs, according to Cerulli Associates. The growth of UMAs helps with the growth of all vehicles – mutual funds, ETFs and SMAs – but is a particular boon for the latter, making them more accessible to advisors than ever before. At the end of 2019, discretionary and non-discretionary UMAs at the major wires and broker-dealers accounted for $993.1bn and $374.7bn, respectively, having grown 43% and 25% from the previous year, Cerulli found. We hear from four of the country’s largest wirehouses, broker-dealers and Tamps to find out how they are approaching SMAs and UMAs.
According to Cerulli, at the end of 2019, UBS had $122.5bn in single- and dual-contract SMAs as well as proprietary SMAs. This figure may not cover model-delivered SMAs, but it places the firm fourth on the consultant’s list of separate account program sponsors by assets. The no-management-fee proprietary SMAs have proven popular, taking in $9bn of assets in the first quarter of 2020, UBS head of US wealth management Jason Chandler said during a May webinar. Mattus was bullish on the future uptake of SMAs and said the firm has plans to launch several new SMA strategies with no management fees later this year. ‘Our hope is that, over time, this has an impact on the industry as a whole as it relates to pricing,’ he said.
UBS Global Wealth Management UBS Wealth Management hit the headlines last year when it announced plans to eliminate management fees for clients buying certain SMAs via the firm’s single-contract SMA and UMA programs, called Access and Strategic Wealth Portfolio, respectively. Initially, the only SMAs on the two programs with no traditional management fees were those strategies run by the wirehouse’s own investment arm, UBS Asset Management. Announcing this move in October last year, Suni Harford, UBS Asset Management president, and Tom Naratil, co-president of UBS Global Wealth Management, said that some SMAs from third-party managers would also be offered with no management fee by the middle of 2020. A spokesman for the firm said this is now the case but declined to reveal their names. Naratil and Harford said the fee structure was designed to ensure UBS ‘further aligned’ with the Securities and Exchange Commission’s Regulation Best Interest rule, which requires firms to disclose or eliminate conflicts of interest, such as offering proprietary strategies on a wealth management platform. Steven Mattus, the firm’s head of advisory products for the Americas, told Citywire: ‘Typically, the advisory fee made up a majority of the overall fee to the client, and the manager fee was a smaller portion, but still stubbornly high relative to some other vehicles like ETFs, where we’ve seen expense ratios come way down. ’‘Our view is that we should be able to get more institutional-type pricing from managers and pass that along to our clients, thereby bringing down the manager fee portion [of the overall fee],’ he added. In October 2019, The Wall Street Journal reported that the typical advisory fee was 1%, with the SMA management fee accounting for around a third of this. According to the firm’s Form ADV filing from March, third-party SMA providers charged management fees typically between 0.2% and 0.75% for equity strategies and 0.10% to 0.60% for bonds. Under the new pricing structure, providers will not be giving their services away for free, but rather than be paid directly by each client for every account, they will be paid a fee by UBS based on the total amount of assets they run, with clients just paying the advisory fee to UBS. This fee model will not apply for customized SMAs, such as those that perform tax-loss harvesting or offer an ESG overlay. UBS Global Wealth Management’s Americas business had $1.2tn in invested assets at the end of the first quarter of 2020. The advisory business accounts for roughly 40% of that figure, and SMA assets represent about a quarter of the invested advisory assets.
Edward Jones Currently, Edward Jones offers about 50 SMAs on its program list, according to Tim Baldes, the firm’s principal of investment manager research. He oversees SMAs available through the firm’s Unified Managed Account (UMA) models, which sit within the discretionary model platform. SMAs represent about $10bn of the $200bn the firm has in its discretionary model portfolios. Edward Jones has a firm-wide total of $1.3tn in assets across advisory and brokerage business. The UMA platform is a single-contract platform, Baldes explained, with the home-office team overseeing all of the strategies offered to the firm’s advisory clients. ‘We essentially are asked to be the oversight and informed buyer for our clients to help them select investments that are suitable and good quality for their portfolio,’ Baldes said. ‘Our objective for all of the strategies is to outperform both the index and the respective peer set. ’Baldes said he has seen SMAs increase in popularity, which he attributes partly to investors’ ability to own the underlying holdings, among other qualities. This sets them apart from other vehicles, like ETFs. SMAs’ relatively low cost, while not often comparable to an ETF, can also set the vehicle apart from a mutual fund during the due diligence process. ‘That’s the beauty of an SMA strategy, to own the underlying holdings and have the ability to do tax-loss harvesting, which you can’t do in an ETF wrapper,’ he said. ‘SMAs have largely been a lower-cost fee structure for quite some time, which has made them relatively attractive compared to other actively managed counterparts, whether you’re talking about management fees or about the other fees, like the administrative costs and the distribution costs that are wrapped into that as well.
Baldes added that, while lower fees are part of the draw of SMAs, compression across vehicles in the asset management industry has been hard to ignore. ‘The relative advantage [of lower fees], in our opinion, is actually compressed a bit over time,’ he said. When asked about the firm’s plans to expand its SMA offering, Baldes hedged, but said there was potential to grow the platform. ‘There are some things in the works as it relates to our advisory business,’ he said. ‘One of the things that we do see is an opportunity in SMAs and [to have] the ability for our clients to utilize them more broadly, take the less than $10bn of current assets and grow that part of our business.’
Envestnet Envestnet is an open-architecture platform, so it offers investors thousands of SMAs that go through an onboarding process. Tim Clift, the firm’s chief investment strategist, leads the team that conducts due diligence on those SMAs that have a shot at making it onto the firm’s high-conviction list. Clift said that, of the thousands of SMAs on Envestnet’s platform, his team generally selects products that have a five-year track record and at least $200m in assets, though he said there are exceptions. ‘I think there is more and more demand for customization, because we’re seeing more organizations, including ourselves, focusing on that area and being able to create a financial plan for a customer that is meeting all their unique needs,’ he said.
Clift said he has not noticed a particular spike in investor interest in SMAs, but that for some high net worth clients, the tax benefits have made the vehicle attractive. ‘I don’t necessarily know if they’ve gotten more popular, but we haven’t seen a slowdown in adoption,’ he said. ‘For clients that are looking for the tax-management part of it and owning the cost basis, it’s becoming more and more popular.’ Clift doesn’t think the vehicle will replace the mutual fund anytime soon, particularly when it comes to smaller investments. While high net worth clients can benefit from the SMA capital gains regime, investors who can only buy a smaller piece of the pie will still need a vehicle to invest in at a lower rate, he said. ‘I think the big benefit of mutual funds is that they’re very accessible to small balances. You can buy into mutual funds for $1,000, whereas, historically, with SMAs, the minimum has been $100,000. Although that has crept down to $50,000, $40,000 or even $25,000, they’re still not going to, at least at this point, be able to replace mutual funds as a small-account solution,’ he said.
EWells Fargo Advisors Wells Fargo has also made strides in the SMA space, according to Patty Loepker, head of research-directed advisory programs at Wells Fargo Advisors. Loepker said the firm does business with about 150 managers and offers 350 individual strategies across asset classes and styles. The firm ranks fifth on Cerulli’s list of separate account program sponsors by assets, with $97.8bn as of the end of 2019, representing an 8.2% market share. This figure does not include model-delivered offerings. When it comes to approving an SMA, Loepker said the firm’s manager research team gets the final say. ‘We rely solely on the research done by the global manager research team within the Wells Fargo Investment Institute for the review of our SMA strategies. They have to bless it or our financial advisors cannot recommend it to their clients,’ she said. Loepker said that, while fixed income SMAs have been slower to grow than equity SMAs, she expected the asset class to become more popular and widely available inside an SMA at Wells Fargo in the future.
‘I think that, especially given the tax benefits that a client can enjoy when they own SMAs, that extra level of service is the added value that many advisors are working to bring to their clients to help meet multiple needs for that client,’ she said. ‘We’ve experienced that ourselves, and I would love for us to continue to grow our SMA offering.’
Past performance is not a reliable indicator of future performance. Mondrian Investment Partners Limited is authorised and regulated by the Financial Conduct Authority. Views expressed were current as of the date indicated, are subject to change, and may not reflect current views. Views should not be considered a recommendation to buy, hold or sell any security and should not be relied on as research or investment advice. An investment involves the risk of loss, including the loss of principal. There can be no assurance that the investment objectives of the strategy will be achieved. May 2020.
With an international equity SMA strategy that has proven successful, the firm is expanding its model delivery offerings to the intermediary market
Mondrian Investment Partners is expanding its vehicle offering to give greater access to advisors looking to capitalize on the investment philosophy that has been at its heart for 30 years – an income-oriented value discipline that has proven defensive in challenging markets. The London-based asset manager, with North American client service operations in Philadelphia, manages $45bn, primarily in international equity and fixed income strategies for institutions. However, they are not strangers to the intermediary market. For more than 2 decades Mondrian has managed an International Equity ADR strategy through a subadvisor partnership with Delaware Funds by Macquarie. Today that strategy represents approximately $4billon and is distributed exclusively by Delaware and targeted at a limited number of intermediaries. Mondrian also has its own focused family of mutual funds. ‘Our partnership with Delaware has been so successful that we are one of the largest separately managed account (SMA) providers in the international value category, so it’s not something that’s particularly new to us,’ says Clive Gillmore, Mondrian’s CEO and group CIO. ‘What is new is that, since January, outside this targeted list, we have been independently offering model delivery of our International ADR strategy, directly to the intermediary market to go hand in glove with our mutual funds and cover the full spectrum of clients.’ Strategically, Mondrian views advisor-based intermediaries as a faster growth market and Gillmore is confident of attracting at least $10bn in the medium term – and potentially more. Funds as well as Model Delivery Henry Orvin, a senior vice president at Mondrian in Philadelphia, can tell from his discussions with intermediaries that ‘the demand continues to grow for SMA – the top advisors want to bring it to their largest clients as an additional tool for building out their overall portfolio. It’s a case of advisors wanting fewer, higher-conviction strategies and utilizing two vehicles,’ he says. ‘They have selected a manager and now have the ability to bring that manager to their clients in a mutual fund or SMA.’ A more efficient marketThe rise of technology has hugely benefited the SMA market in terms of product availability and distribution. The ability to deliver models through unified managed accounts (single account multi-asset portfolios tailored to each client’s needs) and the centralization of portfolio manager selection through investment due-diligence platforms have made it more attractive for a mid-sized manager such as Mondrian to expand in the SMA market. By leveraging these efficiencies, it can reach a wider intermediary audience without significantly growing its head count of less than 200 or compromising its investment boutique culture. ‘We’re an institutional manager with a proven defensive value approach,’ says Philadelphia-based senior vice president Dave Hogan. ‘Our clients know the characteristics we produce in different markets and with UMA model delivery we can now more fully offer that portfolio intellectual capital to the intermediary market.’Maturation of the securities market has also been a factor. The growth in the American depositary receipt (ADR) universe has been ‘a bit of a game changer’ according to Gillmore. As primarily an international manager, Mondrian has long used international ADRs in developed equity SMAs, but their greater availability has paved the way for offering global equity and emerging markets SMAs for strategies that Mondrian has managed in the institutional space for decades. These sit alongside their US large-cap value and US small-cap products that have been compelling as well when compared to their respective benchmarks. Gillmore believes that all of these capabilities have potential for model delivery SMA. SMAs afford greater flexibility over where assets are invested – a boon in a world in which environmental, social and governance (ESG) concerns are coming to the fore. ‘It’s ubiquitous in Europe to talk about ESG investing – North America is following suit – but one size doesn’t fit all and SMAs have an advantage here,’ says Gillmore as Mondrian has worked with accounts that have wanted to screen out companies or whole industry sectors for a variety investor reasons. They also manage ESG accounts more proactively by taking a principle-based approach. Tax-loss harvesting – selling loss-making securities to offset taxes on both gains and income – is another key advantage and one that stands to become potentially more important amid the longer-term fallout from the current Covid-19 pandemic. ‘Understandably, governments have chosen to focus on preserving life in the short term. They are now turning their attention to preserving livelihoods and throwing huge amounts of money at the problem,’ adds Gillmore. ‘SMAs, as a bespoke solution, might help in the future for individuals who are going to end up with bigger tax bills than they have today.’Proven approachWhile value as a broad strategy has lagged growth since 2007 and suffered disproportionately in the current bear market – the fastest-falling of all time – the dividend discount approach that Mondrian has used since its founding in 1990 has demonstrated less volatility and more historical defensiveness during market drawdowns. Unlike value investors who aim to catch a falling knife – buying distressed situations that may or may not turn around – Mondrian’s investment team focuses on future income streams and rigorous stress testing to ascertain downside risk. ‘We do what we say, and do it over time – our clients like the stability. They can add hot dots as satellites, but we are at the core and that gives them comfort,’ Orvin says.New opportunity for advisors As a growing band of advisors, including those at big wealth managers and those that have gone independent, are looking to offer their clients something different, Mondrian may offer another advantage. For many, the uniqueness of a well-established London-based manager that hasn’t yet fully saturated the intermediary market is intriguing.‘Offering ideas that are new is an advantage that advisors can bring to their clients,’ Orvin adds. ‘Their job is to find the areas that are undervalued – international markets versus the US, value versus growth – and put their clients with managers that can make a difference’ ‘The evolution of model delivery SMA allows us to provide the same expertise to advisors’ clients that was formerly reserved for multi-$billion corporate clients. You can diversify your clients’ money internationally with a value approach that seeks low volatility and downside protection. To borrow from Wayne Gretzky, you can “skate to where the puck is going, not to where it has been”.’
Clive Gillmore CEO & Group CIO Mondrian Investment Partners
David Hogan Senior Vice President Mondrian Investment Partners
Henry Orvin Senior Vice President Mondrian Investment Partners
Funds as well as Model Delivery Henry Orvin, a senior vice president at Mondrian in Philadelphia, can tell from his discussions with intermediaries that ‘the demand continues to grow for SMA – the top advisors want to bring it to their largest clients as an additional tool for building out their overall portfolio. It’s a case of advisors wanting fewer, higher-conviction strategies and utilizing two vehicles,’ he says. ‘They have selected a manager and now have the ability to bring that manager to their clients in a mutual fund or SMA.’
A more efficient market The rise of technology has hugely benefited the SMA market in terms of product availability and distribution. The ability to deliver models through unified managed accounts (single account multi-asset portfolios tailored to each client’s needs) and the centralization of portfolio manager selection through investment due-diligence platforms have made it more attractive for a mid-sized manager such as Mondrian to expand in the SMA market. By leveraging these efficiencies, it can reach a wider intermediary audience without significantly growing its head count of less than 200 or compromising its investment boutique culture. ‘We’re an institutional manager with a proven defensive value approach,’ says Philadelphia-based senior vice president Dave Hogan. ‘Our clients know the characteristics we produce in different markets and with UMA model delivery we can now more fully offer that portfolio intellectual capital to the intermediary market. ’Maturation of the securities market has also been a factor. The growth in the American depositary receipt (ADR) universe has been ‘a bit of a game changer’ according to Gillmore. As primarily an international manager, Mondrian has long used international ADRs in developed equity SMAs, but their greater availability has paved the way for offering global equity and emerging markets SMAs for strategies that Mondrian has managed in the institutional space for decades. These sit alongside their US large-cap value and US small-cap products that have been compelling as well when compared to their respective benchmarks. Gillmore believes that all of these capabilities have potential for model delivery SMA. SMAs afford greater flexibility over where assets are invested – a boon in a world in which environmental, social and governance (ESG) concerns are coming to the fore. ‘It’s ubiquitous in Europe to talk about ESG investing – North America is following suit – but one size doesn’t fit all and SMAs have an advantage here,’ says Gillmore as Mondrian has worked with accounts that have wanted to screen out companies or whole industry sectors for a variety investor reasons. They also manage ESG accounts more proactively by taking a principle-based approach. Tax-loss harvesting – selling loss-making securities to offset taxes on both gains and income – is another key advantage and one that stands to become potentially more important amid the longer-term fallout from the current Covid-19 pandemic. ‘Understandably, governments have chosen to focus on preserving life in the short term. They are now turning their attention to preserving livelihoods and throwing huge amounts of money at the problem,’ adds Gillmore. ‘SMAs, as a bespoke solution, might help in the future for individuals who are going to end up with bigger tax bills than they have today.’ Proven approach While value as a broad strategy has lagged growth since 2007 and suffered disproportionately in the current bear market – the fastest-falling of all time – the dividend discount approach that Mondrian has used since its founding in 1990 has demonstrated less volatility and more historical defensiveness during market drawdowns. Unlike value investors who aim to catch a falling knife – buying distressed situations that may or may not turn around – Mondrian’s investment team focuses on future income streams and rigorous stress testing to ascertain downside risk. ‘We do what we say, and do it over time – our clients like the stability. They can add hot dots as satellites, but we are at the core and that gives them comfort,’ Orvin says. New opportunity for advisors As a growing band of advisors, including those at big wealth managers and those that have gone independent, are looking to offer their clients something different, Mondrian may offer another advantage. For many, the uniqueness of a well-established London-based manager that hasn’t yet fully saturated the intermediary market is intriguing.‘Offering ideas that are new is an advantage that advisors can bring to their clients,’ Orvin adds. ‘Their job is to find the areas that are undervalued – international markets versus the US, value versus growth – and put their clients with managers that can make a difference’ ‘The evolution of model delivery SMA allows us to provide the same expertise to advisors’ clients that was formerly reserved for multi-$billion corporate clients. You can diversify your clients’ money internationally with a value approach that seeks low volatility and downside protection. To borrow from Wayne Gretzky, you can “skate to where the puck is going, not to where it has been”.’
Past performance should not be taken as a guide to the future. The Strategy’s objectives will not necessarily be achieved and there is no guarantee that these investments will make profits; losses may be made. This communication is for institutional investors and financial advisors only and is not an invitation to make an investment nor does it constitute an offer for sale. This is not a buy, sell or hold recommendation for any particular security. Any decision to invest should be made after conducting such investigation as an investor deems necessary and consulting its own legal, accounting and tax advisors in order to make an independent determination of suitability and consequences of such an investment. This material does not purport to be a complete summary of all the risks associated with this offering. A description of risks associated with this offering will be made available on request. Ninety One North America, Inc. (“Ninety One”) acts as a non-discretionary model provider in a variety of separately managed account programs (each, an “SMA Program”) sponsored either by a third-party investment adviser, broker-dealer or other financial services firm (a “Sponsor”). Ninety One’s responsibility is limited to providing non-discretionary investment recommendations (in the form of model portfolios) to the SMA Program Sponsor, and the Sponsor may utilize such recommendations in connection with its management of SMA Program accounts. In such “model-based” SMA Programs (“Model-Based Programs”), it is the Sponsor, and not Ninety One, which serves as the investment manager to, and has trade implementation responsibility for, the Model-Based Program accounts. © 2020 Ninety One. All rights reserved. Issued by Ninety One, May 2020.
Clyde Rossouw explains why quality companies can be resilient in tough times and may grow rapidly in recoveries
The case for quality investing — building a portfolio of companies with competitive advantages, strong market positions, healthy balance sheets, sustainable revenues and low sensitivity to the economic cycle — is obvious when markets are stormy. With the brakes slammed on the global economy due to the coronavirus and the near-term outlook extremely uncertain, these are attributes many investors would wish for among their holdings. Less discussed is the potential for quality companies to grow robustly in a recovering market. Amid the wreckage of weaker businesses as the dust settles, they often get a head start on growth that can propel them through the next cycle. Simply put, after a shake-out, the strong tend to get stronger. History suggests this has helped some quality companies’ stock prices outperform as a recovery gets underway. A key attribute that helps quality companies not only survive a downturn but continue to expand in the aftermath is their strong cash positions: or, more specifically, the fact they tend to be both cash-flow resilient and to have cash on hand (accessible cash). They say cash is king. After a crunch, possessing these twin cash advantages can be a kingmaker, helping quality businesses increase their market dominance.
Clyde Rossouw Co-Head of Quality Ninety One
What is a quality company? Quality companies, as we define them, have five attributes, as shown in the figure. These characteristics help quality companies survive a market crisis and the slowdown that sometimes follows: Whatever the economic backdrop, revenues usually keep flowing for quality companies. This is partly because they offer products and services that people need, often sold via subscription or as recurring purchases. They also tend to operate in growing industries where they have competitive advantages. They often have dominant market positions, which means they may have pricing power - giving additional protection in a downturn. Quality companies tend to have low operating expenses, especially low fixed costs. They are also capital light, meaning they don’t need to spend a lot on maintaining, say, factories or sophisticated machinery just to stay in business. With many companies finding that revenues have dried up amid lockdowns, the advantage of being able to control how much money flows out on a monthly basis has rarely, if ever, been so apparent. They also have strong balance sheets with relatively little debt, and typically significant levels of cash and ready access to liquidity/funding on good terms, due to their strong credit ratings.
Together, these attributes give quality companies more flexibility in allocating capital. This can be an advantage not only in challenging times, but also when the storm passes. Increased optionality Flexibility in capital allocation means that, during a crunch, quality companies can be quick to adapt to ensure they remain resilient and to prepare for a changed economic environment. For example, they can suspend buybacks if required as they have not been reliant on borrowing to buy back shares in order to drive earnings-per-share growth. When conditions improve, they can direct capital expenditure to growth initiatives or even spend on acquisitions — often of weaker rivals on very advantageous terms. As a consequence, quality companies can be quick out of the blocks in a recovery. Out of the ashes … but remember valuations! With the trajectory of the coronavirus pandemic not clear we feel quality companies have the resilience to better weather it. Not only that, when the shoots of recovery do appear, they should be well placed to take advantage. We have found that to be the case while managing Ninety One’s Global Franchise strategy since 2007: during market downturns, quality companies have provided some downside protection, falling less than the overall market, and they have then outperformed in the aftermath. Of course, those seeking to follow a quality investment style need to maintain valuation discipline, buying shares in quality companies at reasonable prices. After recent largely indiscriminate sell-offs, there is a good opportunity to build a quality portfolio at lower valuations. And whether what follows the current turmoil is a prolonged slowdown or a swift bounce back, a quality portfolio’s combination of resilience in hard times and strong growth potential in recoveries could stand investors in good stead.
About Ninety One Global Franchise ADR SMA The Ninety One Global Franchise ADR SMA is a high conviction portfolio of currently 28 holdings focusing on world-leading companies in their field. It aims to invest in businesses which will perform through the cycle and during uncertain times when economic growth is scarce. For more information, please visit: ninetyone.com/int/quality
Henry Ford might not have been a fan of the SMA. The automobile pioneer famously told his sales force: ‘Any customer can have a car painted any color that he wants so long as it is black.’ In his 1922 business manual, the humbly titled My Life and Work, Ford explained that his sales team were too interested in satisfying the whims of clients and should instead understand their products better and explain to clients why their desires were wrong. It is fair to assume he might not have cut it in asset management in 2020, particularly selling SMAs. Ask pretty much any asset manager about the virtues of the vehicle and you’ll get variations of the same answer: It’s all about customization and the ability to tailor strategies to specific needs and desires of individual clients. The most popular two examples of this are tax management and ESG strategies. ‘As advisors have thought about what services they offer clients, they want to offer them more and more things that just can’t be purchased by a client on their own,’ said Matt Witkos, head of global distribution at Eaton Vance. ‘[And] someone trying to set up their own customized index – and for that to be tax-advantaged – is pretty time-consuming, probably almost impossible.’ As BlackRock’s head of managed accounts, Greg Weiss, put it: ‘Mass personalization is now the new product and taxes are the new alpha.’ He added: ‘We have more clients with customized SMAs than you can sit in Citi Field.’ For those interested, the Mets stadium has a seating capacity of 41,922. Weiss said investors’ preference for tax-managed strategies had been driving flows to both equity-based strategies that employed tax-loss harvesting – selling securities that have fallen in value and replacing them with similar stocks, using the loss from the initial sale to offset any realized gain – and fixed income strategies, particularly municipal bond ladders. This is borne out in the two firms’ SMA assets under management. According to Cerulli Associates, Eaton Vance and BlackRock are numbers one and two, respectively, on the consultant’s list of largest retail SMA managers. At the end of 2019, according to Cerulli, Eaton Vance had $154.1bn and BlackRock had $119.8bn in SMA assets under management through programs at the major wirehouses and broker-dealers. The vast majority of Eaton Vance’s assets ($104.6bn) were run by its subsidiary, Parametric Portfolio Associates, which specializes in custom indices and tax-managed strategies. ‘ We’ve been able to innovate the way we take in securities and customize whether it’s a muni ladder or an equity index for clients,’ Witkos said. ‘We’re seeing that more people are understanding the benefits of tax-loss harvesting.’ He said this was likely to become an even higher priority in 2020 as it is an election year, a time when clients typically become more concerned about tax, as a change in administration can lead to a change in rules.
Muni wonderland Within manager-traded SMAs, municipal bond strategies were the most popular asset class at the end of 2019, with $181.1bn in assets, according to Cerulli. This has not always been the case and reflects the role of tax management in the popularity of SMAs. ‘If you look back 10 or 15 years, the [SMA] asset base was heavily dominated in the equity side of things. And it still is. But fixed income, and even more so municipal fixed income, has become a dominant asset base,’ said Brian Silverman, head of SMA at Franklin Templeton. Strong demand for munis has been seen in mutual funds too. The Morningstar Municipal Bond category had seen net inflows in every month of 2019 and began 2020 by taking in $14.1bn in January, a record month. Even in February, as the selloff began, muni funds took in $10.8bn. This obviously reversed in March, but demonstrates the level of demand for these strategies, something Silverman put down to changes in state and local tax deductions, the hunt for yield in a low-rate environment and advisors’ post-2008 realization that trading individual bonds was a risky business better executed by professional money managers. Franklin is placing a renewed focus on its SMA business, with Silverman joining last year from BlackRock to spearhead this initiative. The firm is also in the process of acquiring Legg Mason, which is the third-largest player in the retail SMA market, according to Cerulli, with $94.1bn in assets. Franklin’s focus on munis has been a boon in 2020, Silverman said, highlighting that the firm’s muni SMAs sales were up 50% on the previous year. He said some of this was down to demand for the asset class, but also reflected the firm’s willingness to customize, offering muni strategies in 20 specific states as well as a green bond mandate.
Green shoots While ESG is not an asset class, meaning flows cannot be tracked in the same way as munis, it is an area of growing demand in all vehicles. ESG mutual funds and ETFs are set for a record year, even with the selloff, and SMAs are perfectly placed to exploit this trend given that they can be customized to suit an individual’s values. The vehicle’s ability to do this is not new, but technological advances allowing it to be done cheaply and therefore at scale, are significant, according to Witkos. ‘Customization has been around a long time,’ he said. ‘In the 1990s, you could get a large-cap value portfolio and say that you don’t want any fossil fuels in there. But now people are wanting more and more customization where not only do they want to have something that can be ESG-orientated, they want to see how you’re going to vote the proxies.’
And SMAs can meet that need, he added. ‘You could create a whole portfolio that is aligned to their beliefs,’ he said. Witkos highlighted another Eaton Vance subsidiary, Calvert Research and Management, which specializes in ESG investments that offer both custom equity index-based SMAs and bond strategies that can be run to avoid issuances from the likes of prisons or stadiums. ‘We are seeing a demand for things like that,’ he said. ‘And that doesn’t surprise me, given the environment we’re in right now.’ The firm is not letting the opportunity pass it by. At the beginning of June, it launched a new range of eight ESG SMAs, called the Calvert ESG Leaders Strategies. The equity strategies invest in stocks of selected companies with leading ESG criteria based on Calvert’s proprietary methodology, which the firm believes are material to long-term performance. Calvert will also work with Parametric to offer tax-managed versions of some of the SMAs. What’s next? While tax management and ESG strategies are unlikely to fall out of favor any time soon, asset managers are busy innovating elsewhere in an effort to stay at the top of the SMA market. Two areas of emphasis are finding ways to access asset classes that do not easily fit into the SMA format due to the way they are traded and building income-focused portfolios. ‘There are always going to be asset classes that you probably won’t find in the SMA business. But what you’ll start seeing are solutions being put together using different structures,’ Witkos said. ‘[For example,] using individual securities, and then either adding in ETFs, closed-end funds or other exchange-traded structures that can maybe enhance yield, tax-loss harvesting or exposures to asset classes like bank loans as well as emerging market debt that you can’t get in an SMA. ’Silverman said Franklin was working on bringing a version of its $64.7bn Franklin Income fund to the SMA market and that it would do this by employing a similar approach to the one set out by Witkos. ‘It is very difficult in SMAs to offer a fully integrated multi-asset solution using individual securities,’ he said. ‘Therefore, we utilize “completion funds.” So approximately 60% of the portfolio would be using individual stocks and bonds and the remaining 40% uses funds that get us exposure to asset classes that are difficult to access in individual security at lower account sizes.’ Witkos said SMAs that invested in securities as well as ETFs and closed-end funds could also be used as retirement products that generated an income and allowed clients to draw down their money in a tax-efficient way. ‘I don’t want to call it personalized pension plans, but I can imagine a state where people use SMAs, build a core bond portfolio, add closed-end funds and ETFs around it, and say, “I need so much to live per month, and I need to draw that down in a very tax-efficient way,”’ he said. ‘As technology gets better, operational effectiveness and efficiency gets better, you’re going to be able to implement much better solutions for clients… like delivering on retirement income and doing tax management and drawing down the client’s assets. To me, that’s probably the future right there.’
*PIMCO management fee. Not reflective of wrap program fees. The managed account strategies described in this material are offered by Pacific Investment Management Company LLC and Gurtin Municipal Bond Management, and are available exclusively through financial professionals. Managed accounts have a minimum asset level and may not be suitable for all investors. Financial professionals seeking more information should contact their managed accounts department or call their PIMCO representative. Select Managed Accounts strategies consist of individual securities and a select combination of proprietary, commingled vehicles. These vehicles are available only through managed accounts utilizing the Managed Accounts strategy and are available by prospectus only. Individual account holdings will vary depending on the size of an account, cash flows and account restrictions. Portfolio holdings are subject to change daily without notice. At any time an individual account managed in this strategy may or may not include securities held by another portfolio. Consequently, any particular account may have portfolio characteristics and performance that differ from another individual account in this strategy. A word about risk: All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. PIMCO does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Any tax statements contained herein are not intended or written to be used, and cannot be relied upon or used for the purpose of avoiding penalties imposed by the Internal Revenue Service or state and local tax authorities. Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement. PIMCO acquired Gurtin Municipal Bond Management on January 2, 2019. PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This material contains the current opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2020, PIMCO. CMR2020-0515-1187821
The markets have proven over time to be no exception to the old adage that “the only constant in life is change.” As the markets have changed, so have investor needs. Separately managed accounts, or SMAs, have become more prevalent and important for our clients and their financial advisors. In 2019, PIMCO acquired a firm actively involved in SMA management – PIMCO’s first-ever acquisition. With this strategic investment in SMA technology and an enhanced suite of SMA strategies, PIMCO is seeking to help financial advisors better respond to clients’ changing needs and provide more differentiated SMA offerings. SMAs can satisfy clients’ growing desire for investment control The strong growth in SMAs in recent years is likely no coincidence given that the potential for greater control resonates with investors who witnessed the volatility and uncertainty of 2008. The financial crisis reminded us that information transparency is critical to understanding and managing investment risks. Offering both real-time visibility into holdings and direct ownership of securities, an SMA can be a solution for investors seeking to better understand portfolio management decisions, including decisions that might affect their tax situation. Because SMA investors own the securities directly, SMAs can help investors manage tax liabilities. The ability to hold securities to maturity allows investors flexibility for how they react to any mark-to-market price volatility, and with greater control over buy/sell timing, an SMA investor can sell as liquidity needs arise, taking into account which bonds are most favorable to sell from a personal tax perspective. Further, SMAs can allow for tax-loss harvesting, as individual positions may be sold to realize losses to help reduce tax bills. Differentiating SMA offerings with technology When building investment portfolios designed to deliver on individual client objectives while staying within clients’ varying risk parameters, cost-effective customization can be essential. With every client having differing requisites as to income, growth, liquidity, and risk, “off-the-shelf” or “one-size-fits-all” solutions can be inadequate. And in a growing and increasingly competitive market, SMAs that leverage innovative technology to answer investors’ demand for customized or lower-cost investments can be an effective way for financial advisors to offer differentiated products and services. “We made a strategic investment in building proprietary technology because we realized that not all SMAs are created equal,” said Michael Johnson, PIMCO’s head of SMA operations and technology. “Our investment in technology has not only enhanced our ability to customize and manage SMAs, but it’s also enabled our RIA partners to present enhanced offerings at a competitive cost and further set themselves apart.” With the technological tools to efficiently build personalized portfolios, PIMCO enables advisors to offer products that are customized across more traditional variables such as tax considerations, credit risk tolerance, and time horizons, as well as nontraditional variables such as ESG (environmental, social, and governance) or SRI (socially responsible investing) investment overlays. Further, PIMCO supplements these enhanced solutions with technology-enabled services such as year-round tax loss harvesting, in-kind portfolio reviews, and detailed reporting – inclusive within its management fees.* “We believe that helping advisors navigate market change should extend beyond portfolio management,” said Mark Thomas, PIMCO’s head of SMAs and models for the wealth management team in the U.S. “As a partner to financial advisors looking to maintain and grow investor wealth, we want to help make their job easier – particularly in an SMA market that’s as competitive as it is today. That means going above and beyond.”
To learn more, visit PIMCO.com/managed-accounts
Eric J. Mogelof Head of U.S. Global Wealth Management
Mark Thomas Head of SMAs and Models
Michael Johnson Head of SMA Operations and Technology
Thinking Beyond The Benchmark: KAR Small-Mid Cap Core SMA Portfolio
Risk Considerations: Equity Securities: The market price of equity securities may be adversely affected by financial market, industry, or issuer specific events. Focus on a particular style or on small or medium-sized companies may enhance that risk. Limited Number of Investments: Because the fund has a limited number of securities, it may be more susceptible to factors adversely affecting its securities than a less concentrated fund. Industry/Sector Concentration: A fund that focuses its investments in a particular industry or sector will be more sensitive to conditions that affect that industry or sector than a non-concentrated fund. Market Volatility: Local, regional or global events such as war, acts of terrorism, the spread of infectious illness or other public health issue, recessions, or other events could have a significant impact on the fund and its investments, including hampering the ability of the fund’s portfolio manager(s) to invest the fund’s assets as intended.This material is deemed supplemental and complements the performance and disclosure at the end of the KAR Small-Mid Cap Core SMA Portfolio presentation, available at the Virtus website, or by calling 800-243-4361.
Betting on quality for better risk-adjusted performance
Quality businesses have an unmistakable profile: durable earnings growth, high return on capital, strong balance sheets and cash flows, and management acumen at maintaining a competitive advantage. These attributes sound attractive, but do they really make a difference? Kayne Anderson Rudnick (KAR) believes they do. Since 1984, the firm has been guided by these principles, seeking to grow and preserve clients’ wealth responsibly. Nearly four decades later, a focused commitment to owning quality businesses remains central to KAR’s investment culture and the portfolios they manage today. KAR SMALL-MID CAP CORE SMA: A DISTINCT FOCUS ON QUALITY In the ongoing active-vs.-passive debate, data suggests the U.S. small-mid cap asset class offers ample room for skilled active managers to outperform. In KAR’s view, instead of “active or passive?” investors would do well to ask themselves “high quality or low?” To that end, the KAR Small-Mid Cap Core SMA portfolio’s focus on higher quality and lower risk measures has resulted in greater risk-adjusted performance versus the broader stock market. In KAR’s view, the quality of a portfolio’s underlying businesses is a key factor in the consistency of investment performance and risk management. Quality and risk management may seem secondary when U.S. equity markets are advancing and in particularly pronounced bull markets. However, quality companies tend to stand out when equity markets correct. It is especially during more volatile periods—when investors are looking for safety—that quality and risk management count.
PROFITING FROM PROFITABLE COMPANIES The KAR Small-Mid Cap Core SMA is a concentrated, high-conviction portfolio of 25-35 small-to-mid cap companies, typically held two to three years, often longer. Analysis of the strategy provides a clear view into how the quality of its underlying holdings affects the portfolio overall, and demonstrates the importance of quality and risk management to long-term outperformance. The following table compares the companies in the KAR portfolio against holdings in both the Russell 2500 and S&P 500® Indexes. The KAR portfolio provides exposure to higher-quality stocks, focusing on businesses that have generated exceptional returns on shareholders’ capital without employing significant debt, while getting smaller-company exposure at a level of earnings variance similar to that found in larger companies.
ABOUT KAYNE ANDERSON RUDNICK Kayne Anderson Rudnick, an affiliated manager of Virtus Investment Partners since 2001, is an investment and wealth advisory firm whose unique high-quality approach is applied to an array of investment strategies, including small-cap (domestic, international, and emerging markets), small-mid cap, mid-cap, large-cap, all cap, and global yield strategies. KAR had $27.8 billion in assets under management as of March 31, 2020.
QUALITY AS AN OFFSET TO VOLATILITY Careful risk management is a critical component of KAR’s investment approach. Stocks with smaller market caps are generally known for not only the potential to deliver excess returns over larger stocks, but also for potentially higher risk, commonly represented by standard deviation. The KAR portfolio, despite its focus on the small-to-mid capitalization range, has a risk profile equivalent to that of the S&P 500 Index. As shown below, the portfolio exhibits better return per unit of risk (standard deviation divided into annualized return) relative to both the benchmark and broader equity market.
A HISTORY OF ATTRACTIVE DOWNSIDE PROTECTION One final point, the KAR Small-Mid Cap Core SMA portfolio has consistently achieved a downside capture ratio of less than 100 over its lifetime, meaning it has lost less than the Russell 2500 Index during periods of negative returns for the benchmark. This is important because, at the end of the day, investors want a strategy that fulfills a beneficial function, whether return generation, risk mitigation, or a combination of both. Returns and risk must always be observed together, and KAR has been highly disciplined in balancing the two through a consistent focus on quality.
Thinking Beyond The Benchmark: Kar Small-Mid Cap Core Sma Portfolio
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