UMAs: Base Camp for Wealth Managers to Scale Mt. Alpha

Retail Investing 10 Jan 2007

“SMAs grow up and learn to play nicely in the advisory community”
By: Janet Aschkenasy, Wealth Manager Magazine
Published: January 1, 2007

While institutional investors have been busy debating the merits of bifurcating alpha and beta, the wealth management industry has inadvertently stumbled upon an enabling technology that may someday bring alpha-centric investing to the masses.  New information technologies are allowing Separately Managed Accounts (SMAs) to evolve into fully integrated Unified Managed Accounts (UMAs).  In fact, IT consulting firms have suggested this is one of the top IT growth areas for the financial services sector over the next 5 years.

UMAs allow an integrated approach to portfolio construction by streamlining reporting, tax management, and account administration from across several outside asset managers.  In a truly “unified” UMA, managers deliver their models only (they do not technically manage the assets).  Then the advisory firm implements the models and tweaks them where required to meet the specific tax or financial planning requirements of each client.  In doing so, UMAs allow advisors to effectively integrate various alphas and betas (whether they be bundled in long-only accounts or isolated in market neutral hedge funds and ETFs).

According to some, baby boomers desire a more active role in portfolio management.  This creates a fertile ground for a more active approach to “managing managers”:

“The boomers’ experience is not one of high-flying markets like their parents,’ but of volatility, he (Steve Gresham, executive vice president at Phoenix Investment Partners) explains.  ‘To sit still in a long-term SMA arrangement makes no sense to the restless boomer population.  The boomer client comes along and wonders why he can’t have various investments in one account. They think it’s stupid—and it is.’

“The solution? Clients are driving top advisors to purchase opportunistic investments such as ETFs and hedge funds to accompany straight SMA pieces.

“Mutual funds are also being paired with SMAs as part of new UMA strategies. ‘Before, you had individual pieces that had no investment policy pulling them together,’ Gresham explains. ‘That morphed into the managed solution which has now morphed into managed funds with more opportunistic pieces added on. These might include not only alternative investments, ‘but also traditional, bottom-up managers.'”

Clearly, Unified Managed Accounts provide individual investors with an open architecture for alpha-centric investing.  But truly open architectures are still a distant dream for the industry.  According to Wealth Manager, there are three levels of UMA:

  • Model 1 (packaged): where managers are pre-selected in the UMA account
  • Model 2 (hybrid): where advisors have input into manager selection, but are guided by a central group
  • Model 3 (open): advisors make asset allocation decision and select managers for each “sleeve”

Advisors who use “open” UMAs will be able to engineer portfolios that were traditionally the purview of institutional investors:

“Stephen F. Lovell, CFP, CLU, CFS and an advisor with Forsyth Heritage based in Walnut Creek, Calif., says he deals mainly with people 55 and over who welcome his help in assembling guaranteed investments to preserve the wealth they’ve created. This gives them extra freedom with the rest of their money, says Lovell, who recommends some level of SMA exposure to nearly every one of his clients. ‘A lot of studies say combining guaranteed investments with non-guaranteed investments allows you to be aggressive elsewhere to increase the probability of having a sustainable withdrawal rate that doesn’t deplete your assets before you die’.”

This approach to downside-protection in private wealth management bears striking similarities to Alexander Ineichen’s goal of creating alpha for institutional investors through asymmetric returns.  In fact, by attempting to create alpha via down-side protection and then matching his clients’ liabilities, advisor Stephen Lovell has essentially implemented an alpha-centric LDI strategy.

Our point here is that emerging (institutional) approaches to asset management are a lot more relevant to individual investors than we often assume.  For advisors, the freedom of UMAs comes with the responsibility of being able to understand and build portfolios.  At least one leading consultancy believes that advisors will need to upgrade their portfolio construction skills to compete:

“(Cerulli Associates senior analyst Jeff) Strange maintains that it is now incumbent on advisors to move from their traditional focus on product and begin to better understand the sponsor’s manager selection, asset allocation and portfolio construction procedures. ‘In the past, advisors have gravitated toward performance and ‘hot’ products. This is not a terrible thing,’ Strange says, ‘but in the future, I think they will need to become more comfortable with understanding a consistent, repeatable investment process governing their clients’ portfolios.’

As we have discussed, technological and financial innovation have a habit of forcing companies to focus on their core competencies.  Travel agents without the Sabre reservation system were forced to provide knowledge and advice to pay the bills.  Similarly – as Jeff Strange of Ceruilli points out – financial advisors (without captive mutual fund trailers) are forced to provide knowledge and portfolio construction advice to pay the bills.

At the root of both these changes is an open (not proprietary) architecture.  Just ask advisory firms why they are selling off their in-house asset managers.  Armed with an open architecture platform upon which to build a customized solution, financial advisors, like travel agents, are free to do what they do best – advise.

While Bloomberg’s Chet Currier may be right that it will be a number of years before alpha-centric investing truly catches on in the retail investment industry, we believe UMA’s represent a base camp from which alpha-centric investing can scale new heights.

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