When building a separately managed account platform, one of the most crucial and often painstaking steps is conducting a manager search and executing the due diligence process.
On a very base level, the financial services industry is like many others in that it feeds off the law of supply and demand. So when setting up shop for the wealthy investor, the best way to get off the ground is to identify a market or product need, whether it be a fixed-income or a small-cap equity offering. Once that need has been identified, initial screens can be made.
"The whole process is about matching up what we have with what a firm is looking for," said Mark Meyer, executive vice president and national sales director at Franklin Templeton Private Client Group, which sells pretty much everything but mutual funds. For example, Smith Barney is currently looking at various products and is scrutinizing a number of SMA managers. Meyer said that his team views this as an opportunity to feel Smith Barney out on different products Franklin has to offer.
The next step is to arrange a meeting or conference to discuss the products and services being offered. Meyer noted that it often takes several points of contact before serious negotiations commence. This involves a series of follow-up meetings and presentations outlining a product's or service's merits. Franklin typically assigns three or four people to work strictly on new product approvals and due diligence.
Once the two sides get a good feel for each other and what each brings to the table, a preliminary decision is made to become business partners. But it doesn't end there. The sponsor committee holds at least one meeting to hash out the details and any concerns its members might have. After the committee gives the thumbs up to proceed, the two parties iron out a contract and prepare to roll out the product. All told, the process can take up to a year to complete, perhaps even longer in some cases.
But not all managers go through such an exhaustive process to be selected. Some management firms get put on the "short list" for approval. This can happen for a variety of reasons. For example, the firm may have had past experience and working relationships with the sponsor. Another factor that could land a firm on the short list is positive feedback from field consultants and advisers. Database screening, either through Mobius or some proprietary database, is another way to achieve fast-track status. The most obvious criterion for getting on the short list is a firm's reputation in the industry.
The managed account business prides itself on doing more than the traditional due diligence from a product approval standpoint. Conventional wisdom dictates that manager selection hinges upon the people managing the portfolios, their philosophy on investing, the process they implement, performance and the fees they charge for services rendered. Indeed, these are critical due-diligence criteria, but sponsor firms must also look carefully at things such as distribution power, account administration, product adaptability, economies of scale and resources.
What separates the men from the boys when it comes to product approval is the ability to help advisers win new money and new accounts. Another winning strategy is to be more relationship-oriented rather than transaction-oriented. Other key traits are having a large, well-trained sales force and superior portfolio managers. Lastly, the focus should be on the adviser or the end client rather than employing a manager-centric view.
Portfolio management is 80% of the reason why a particular investment management firm is picked, according to Meyer. By sitting down with the portfolio managers and picking their brains, one can really get a sense of whether or not they know their stuff. Meyer believes the key is feeling comfortable and knowing that the people who implement the process are good at what they do. "That's really where the rubber meets the road," Meyer said. Other important factors include having the software and infrastructure to support trading, a firm's corporate culture and the type of compensation packages in place to retain top-drawer talent.
But the due-diligence process does not end upon selection. Rather, it is an ongoing effort to evaluate the manager, on a semi-annual or even quarterly basis. There are certain red flags to look for when reviewing a manager such as a possible sale or merger, a reshuffling of investment personnel or a regulatory probe. The potential negative effects of a due-diligence review are firms being put on a watch list, getting a ratings downgrade, or even getting fired, as we have seen in the recent mutual fund scandal. Those scenarios, in turn, could translate into lost new business, substantial outflows, possible layoffs and, in severe cases, possible shutdown or sale of the firm.
Ultimately, a good manager-sponsor relationship is the result of good dialogue between the two entities. Franklin stresses the importance of being communicative, professional and prompt, and facing problems head on. "Most people in this business like it straight, and if there is a problem, you shouldn't spin it. Take the bullet when you deserve it," Meyer said.