Managed accounts, a cornerstone product for big brokerages, are now also becoming increasingly popular at community banks, industry experts say. These accounts, also called separate or individually managed accounts, are portfolios created for wealthy customers. Such accounts, typically having assets of a few hundred thousand to a few million dollars, provide more flexibility and tax benefits than mutual funds, because they allow investors to own stocks directly. One indication of how popular the accounts have become is that Morningstar started rating them for the first time last year.
Citizens Banking Corp., of Flint, Mich., began offering separate accounts in November. "We're ramping up right now," said Jim Schmelter, an executive vice president at Citizens. "Our clients understand what the products are now, and there is strong demand." The $8 billion-asset banking company's separate account assets are now in the "low seven-figure range," Schmelter said. Eventually, Citizens would like to have all its eligible customers in such accounts.
Some community bank trust departments, where the separate account business is usually housed, say half of their investments could be in such accounts within five years. However, others say they are skeptical that the new product will catch on quickly because of their high investment minimums and the fact that they compete with banks' in-house portfolio managers.
Ron Mastrogiovanni, an executive vice president at FundQuest, a Boston company that offers separate account platforms to banks, said many relationship managers also manage their clients' money personally, and they are loath to hand the job over to outsiders.
But hesitancy to recommend a product managed by outsiders could come back to bite banks, according to Mastrogiovanni.
"Banks are competing with wirehouses, which are selling separately managed accounts," he said. "The wirehouses have done due diligence and picked the best managers in each style and category, including their own managers. And they are telling clients, When you select a bank, the bank is managing all the assets.'"
E.F. Hutton & Co. introduced the first separate accounts in the mid-1970s. Assets under management in these accounts are expected to reach $3 trillion by 2011, up from $400 billion just two years ago, according to Financial Research Corp. in Boston.
The accounts currently hold about 20% of the nation's investment assets, and big brokerages control as much as 80% of the accounts, according to FRC.
But Mike Evans, the director of separate account research at FRC, said banks have been increasingly jumping on the bandwagon. Over the past year, their share of separate account assets increased to 6% from 4%, he said.
And even though they will not pose a serious threat to the brokerage houses anytime soon, banks will likely keep getting "incremental assets," largely from existing clients who move their investments into separate accounts, Evans said.
Industry insiders and analysts say part of the product's growing popularity stems from negative publicity about mutual fund fees and management over the past couple of years. "I think the mutual fund scandals really educated clients in terms of what all the fees are and how they are structured," Schmelter of Citizens said. "Now they can compare and contrast them with separately managed accounts."
Up-front fees for mutual fund shares can be 4% or more, though the longer the funds are held, the more of a bargain that becomes. Funds often have separate fees for management and for marketing and distribution. Managed account clients are charged an annual fee of about 1% of their assets.
Many customers simply like to feel more in control; with separate accounts, they can pick up the phone and talk to the manager, as they typically cannot do with a mutual fund manager. And the accounts are transparent. Unlike with mutual funds, updated holdings can be seen at any time.
"There's an emotional factor," said Bill Woolbert, a senior vice president of Pennsylvania Trust Co. in Radnor, Pa., which started offering separate accounts in February. "A lot of people like to see what they own, as opposed to [owning] a nebulous mutual fund." Pennsylvania Trust will have a third of its assets in separate accounts within five years if all goes well, Woolbert said.
Clients can have separate accounts customized to strive for a variety of goals, such as tax efficiency or socially progressive investing. Falling investment minimums have also helped boost demand. Minimums were in the $5 million range a few years ago but now have fallen to a tenth of that at Citizens, for example. But Schmelter advises that investments of at least $1 million are needed to have a properly diversified account.
Randy Ciccati, president of PrimeVest Financial Services, a St. Cloud, Minn., third-party marketer of separate account services for financial institutions, said the success of the accounts will depend on the amount of support banks give them, as well as how well bank reps are compensated for selling them.
The traditional commission system can result in smaller payouts to the reps, not to mention less up-front cash for the bank, than would be generated by selling, for example, mutual funds with up-front sales charges, Ciccati said. "The reps can see a decrease in compensation for doing the right thing for the customer, and there can be less [immediate income] for financial institutions' bottom line."
In addition, reps who suspect that their bank will soon be sold may have little desire to sell fee-based investment products such as separately managed accounts, he said. That is because the assets in those accounts, and hence the annual fees based on those assets, will go with the institution rather than the reps.
Ciccati and others say community banks are just starting to grapple with those problems. Citizens, for instance, has sought to get its 40 relationship managers, a quarter of whom are portfolio managers, to buy in to the program by asking them to help select the outside managers.
Pennsylvania Trust plans to have some of its employees focus on the new open-architecture accounts and others on the traditional part of the business, Woolbert said.
And Ciccati said PrimeVest is considering requests from three banks that their own managers be included in the list of portfolio managers available to manage the separate accounts.
Brandon Sharrett, a senior vice president of private banking and trust at SEI Investments, an Oaks, Pa., separate account services provider, said financial institutions must learn to switch-hit to satisfy the demands of both traditional and new trust clients. "It's a transitional time for banks," he said. "They're having to serve multiple masters, and [mutual funds and SMAs] require dramatically different approaches."
FRC's Evans said financial institutions must also persuade their reps that such fee-based products are better for both them and their clients. "This is a challenge, from the wirehouses all the way down to the banks, that they are all trying to overcome," he said. "What they need to do is have their platform brokers take a long-term perspective. If you get a stable base of fee-based assets, you can annuitize your earnings." Research has shown that brokers who rely on products with up-front sales charges actually have to work harder over time to attract enough new clients to earn as much as their fee-based counterparts, Evans said.
Stacey Wall, the president of Pinnacle Trust Co., a $175 million-asset company in Jackson, Miss., that introduced separate accounts three years ago, said building the business started slowly. "We haven't found there to be a tremendous amount of demand."
Still, 15% of Pinnacle's clients are in separate accounts already, and half of its clients could be in them in five years, Wall said. "It is something we have to have in our arsenal to provide for our clients."
The reason Pinnacle must offer the accounts is that the nation's trust business is in the midst of a generational shift, and Baby Boomers will be less apt than their predecessors to have the patience for the traditional, conservative trust department approach to investing, he said.
"There is a difference between the post-World War II generation and the Baby Boom generation," Wall said. "Today's investor is more educated because of the Internet, and Boomers on the whole want to be more informed about what's going on with the portfolios."
Steve Conley, the head of brokerage at American Savings Bank in Portsmouth, Ohio, said the stock market's fall back to earth, and the consequent losses in clients' portfolios, left some investors wondering why they were still paying a fee. "That was kind of hard on them," Conley said. American Savings' clients had $3 million of assets in separate accounts a few years ago. Then the stock market's decline took a bite out of the assets, and potential clients steered clear of the product for a while, he said. But now "interest is picking up with the market," Conley said.
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