As unified managed accounts become a larger part of the evolving separately managed accounts (SMA) marketplace, account managers, distributors, technology firms and Depository Trust & Clearing Corp are learning how to avoid "failure to communicate."
Only with standardized protocols for communicating electronically will costly operational mistakes be avoided, they are finding.
A model standards committee of the Money Management Institute has taken the lead, creating guidelines and data formats. These are designed to help investment managers communicate with so-called overlay managers who coordinate investments in and out of investor accounts.
An investment model typically consists of a list of securities with relative weightings in a representative portfolio. Investment managers can change the investment model as often as daily or as infrequently as annually depending on their strategy but they need to tell multiple overlay managers about the change, increasing the potential for error.
The DTCC says it will launch a communications hub called Model Management Exchange later this year that would implement the MMI's standards. Technology vendors, such as Peridrome and Vestmark, have also developed their own models and data formats, for keeping track of what's going on.
Unified managed accounts represented about $123.7 billion of the $2.1 trillion managed accounts market in the fourth quarter of 2010, up from $61.2 billion of the $1.7 billion market in fourth quarter 2009.
In a report published May 4 about model communication practices, Dover Financial Research revealed that 92% of fund managers believed there was "elevated risk" associated with the disparate paper-based means of communication between financial advisers and overlay managers.
"With assets in model programs more than doubling last year, the need for an automated solution to improve control and efficiency in models distribution has never been greater," said Gib Veconi, chief executive of Peridrome, which just announced it started a hosted service called ModelStream. Investment managers can send investment models and changes to models to multiple overlay managers, while tracking the state of each recipient's version of a model at any point in time.
The DTCC will test its MME platform this summer with Morgan Stanley Smith Barney as an overlay manager. Morgan Stanley Smith Barney will be receiving model information from its own financial advisers.
"Our goal is to help the UMA industry become scaleable," said Ann Bergin, director of wealth anaging the risk of errors and containing commanagement services for DTCC. "By providing a central operations infrastructure, the market can grow more efficiently while mmunication costs," she added.
Unified managed accounts are an extension of separately managed accounts. By pulling a client's assets together instead of breaking them up across multiple accounts, UMAs make it easier for the sponsor to keep track of capital gains and losses and improve post-trade tax returns. The account customization for risk and tax management purposes allows financial advisers to better address the needs of their high-net-worth clients, say advocates.
Most large Wall Street wirehouses-such as Morgan Stanley Smith Barney; Bank of America Merrill Lynch and Citigroup-are both sponsors and overlay managers. In a UMA, the overlay manager typically does the trading to control the allocation of shares across multiple investor accounts. By contrast, in a traditional SMA the fund manager has full discretion over trading in client accounts.
"If there is a miscommunications between the investment manager and the overlay manager about changes to the model, the overlay manager could easily buy or sell the wrong security, the wrong number of shares, the wrong value of a security or not make the change in the intended model in a timely fashion," said Jeff Strange, director of research for Cerulli Associates in Boston.
In the case of a separately managed account, a trading mistake could affect only one investor and be caught pretty quickly-typically the next day. But when it comes to unified managed accounts, such a trading error will likely affect hundreds of investors and could take weeks, if not months to uncover.
The mistake is often discovered by the overlay manager during a quarterly analysis of its performance when there is a large discrepancy-typically called "dispersion"-between the performance expected by the financial adviser and that delivered by the overlay manager. One overlay manager who declined to be named estimated that a single trading error could easily cost an overlay manager more than $1 million to correct.
"The overlay manager will rebalance the portfolio-make the necessary purchases or sales of securities at the time and add cash to the account so that the investor is made whole as if the trades had been done when they were supposed to," said Rob Klapprodt, president of Vestmark. "There is not only a financial cost involved with correcting an error but an administrative burden in determining who was at fault because the investment manager and overlay manager will have to track their records and manually reconcile any discrepancies."
Overlay managers using Vestmark's platform to accept investment models include LPL Financial, Natixis Managed Portfolio Advisors, Adhesion, Freestone and UBS Global Asset Management. Edward Jones has also launched a unified managed account program and outsourced overlay management to Natixis Managed Portfolio Advisors.
"Our platform allows the overlay manager to use data formats we established but we also offer the flexibility for them to establish their own data formats and workflow," said Heeren Pathak, chief technology officer for Vestmark. "Standardizing such communication would simplify and streamline operations for overlay and investment managers which is why we provided the MMI with draft specifications."
Among the messages the MMI model standards committee has come up with for the investment manager to send the overlay manager are those which establish their initial relationship with and information about the investment model. Other messages are about updating the investment model, closing or opening the model to new money or cancelling the relationship between the investment manager and overlay manager.
The overlay manager, in turn, can send messages to the investment adviser acknowledging receipt of an initial investment model, any changes to the model or the acceptance or rejection of the model.