Steve Martin once observed famously that in order to become a millionaire and never pay taxes you must "First, get a million dollars." If investing were actually that simple, then the separately managed account business would probably be the most lucrative investment vehicle around.

But the managed account, which many consider a tax-friendly instrument, has long been geared toward the very wealthy, often requiring a minimum investment of $150,000 or more. While that investment minimum seems to be getting lower in recent years, it still remains a product for high-net-worth individuals.

But despite the prohibitive nature of separate accounts, the SMA business has done a standup job in gaining market share, particularly from the mutual fund industry. In fact, from the end of 1999 to the end of 2002 assets in SMAs grew on an annual basis by 4.5% from $350 billion to $399 billion, while long-term mutual fund assets declined by 7.8% from $4.6 trillion to $3.6 trillion, according to Washington-based trade association Money Management Institute (MMI).

MMI recently released the results of its joint survey with Boston's Financial Research Corp., illustrating that the SMA industry's growth can be attributed, for the most part, to the distribution efforts of both new and established asset managers. Nineteen asset managers participated in the survey, representing a broad spectrum of firms, from large retail mutual fund companies to smaller institutional money managers. The firms, separated into three tiers based on the amount of SMA assets under management, are looking to expand their distribution platforms, the survey indicated.

However, that has raised concerns among program sponsors that vital support resources will be spread too thinly across an array of distribution partners. Not to mention, employing multiple distribution platforms can carry enormous costs. The poll revealed that among the Tier 1 firms - those with $5 billion or more in assets - that plan to expand project two to four new relationships in 2003, a 10% increase.

Tier II firms, those with $1 billion to $5 billion in assets, and Tier III firms, having less than $1 billion, plan to be more aggressive in their expansion by forming 4.5 new platforms apiece. Many of the lower-tier asset managers are relatively new to the SMA business, so they are looking to play catch-up with the more established firms.

Another key finding of the survey was the focus of these distribution efforts. The major wirehouse broker/dealers - such as Merrill Lynch and Morgan Stanley - dominate the distribution channel, having locked up 70% of SMA assets under management. Among Tier I firms, the wirehouse channel accounted for 82% of sales in 2002. Mid-sized firms also said that wirehouses ranked first in sales but were not nearly as dominant, having raked in 54% of total sales last year. As for Tier III firms, wirehouses accounted for 47% of sales, although there was far more diversity than there was in the upper tier categories. Nearly 17% of sales in Tier III firms went through regional broker/dealers, and 14% were distributed through a third party.

Given their strong foothold in the separate account business, wirehouses are not expected to relinquish control of the space any time soon. Fund companies entering the SMA business are finding established players already have a huge head start."Brokerage firms have over 10 years under their belt of promoting and training people on the selling of separate accounts," said Don Gartlan, director of Russell Managed Portfolios. "It's hard to catch up to something that is 10 years ahead."

More Specialists

According to the survey, a clear trend that has emerged in the past several years is the increased use of specialists to support various investment products, particularly in the SMA industry. On average, roughly 56% of firms employ SMA product specialists. Again, top-tier firms took the lead with 83% of the firms using product specialists. One out of every two Tier II firms employed specialists, while only 33% of Tier III firms are using them.

Mutual funds, many of which are Tier III firms and new entrants to the SMA business, are finding that their lack of product specialists makes it difficult to provide adequate support for their external marketers. And for the smaller asset management firms, this puts them at a competitive disadvantage. The biggest and most well-established firms employ an average of 6.4 product specialists, while the smaller outfits have an average of three specialists.

In terms of their marketing budgets, the respondents said they increased by an average of 20% in 2002, despite challenging market conditions. The survey suggested that this trend would continue but at a slower pace. Overall, SMAs are expected to remain an attractive retail investment product and should continue to grow more popular. "The aftereffects of market volatility should continue to make SMAs' features and a consultative advisory process attractive to investors for some time to come," wrote Michael Evans, vice president and consultant at FRC.

Copyright 2003 Thomson Media Inc. All Rights Reserved.

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