Without question, the separately managed account industry is undergoing an evolution, led in large part by the industry's own initiatives to move toward the standardization of operating technology. But where are we right now, and what challenges lie ahead on that evolutionary track?
Stephen J. DeAngelis, senior vice president and managing director of PFPC Managed Account Services of Wilmington, Del., recently spoke with Money Management Executive Editor-at-Large Lori Pizzani about how technology is impacting the SMA industry.
DeAngelis joined PFPC as part of the firm's 2003 acquisition of ADVISORport, which DeAngelis co-founded. An edited account of their conversation follows.
MME: The managed account industry, led by a committee of the Money Management Institute (MMI), is working toward developing a single operational standard for managed accounts. Realistically, how far out is that goal?
DeAngelis: Like any new concept or idea, it goes through phases of evolution. First, an organization floats a concept, and the people who are involved nod or shake their heads, and there are usually some delays. Then, if it is still a good enough idea, it hits phase two and moves beyond to early adopters and the trendsetters who are willing to give the concept legs.
If all goes well, it moves into phase three, in which you see much more rapid and broad acceptance of the concept. Many think that the process moves from phase one to phase three very quickly, but it doesn't.
We're now in the early phase two stage. The concept was socialized a year or two ago. Now there's some activity and some good hard work taking place. This is not a light undertaking. It takes a lot of commitment, personnel and dollar capital to implement a new way of doing business. It just needs more time.
The MMI has a great committee helping us to understand what the issues are from the sponsors' and money managers' perspective and laying the groundwork for standards.
It is not that we suddenly have open standards; it will be evolutionary. After a slow start, companies will begin to adopt and, over time, evolve.
MME: Will there be challenges toward developing that standard?
DeAngelis: Yes, it will be challenging. It will take people capital and money capital to adopt these systems if it is going to be done right and allow for new standards of communicating among all sides.
MME: Do you see this as similar to the evolution that the mutual fund industry underwent in the 1980s when it transformed its transactional operations from paper-based to automated through National Securities Clearing Corporation?
DeAngelis: That's a great analogy. The first mutual fund started in 1929 but didn't become common until the 1980s when strides were first made to automate operations. That journey took 60 years!
The assets in mutual funds were able to surpass $10 trillion because the industry evolved from paper-based solutions to automated solutions. But great technology, in and of itself, doesn't predict great success in the marketplace.
The growth of the managed accounts industry will be facilitated by improvements in operations and communications, but it's not the reason assets will grow from the current $1.5 trillion to the $5 trillion some estimate the market will reach in a few years. It's huge demographic trends and the wealth management needs of the Baby Boomers who are taking over more of their retirement planning. That megatrend is the reason managed accounts are growing.
MME: How will small, niche money managers, many of which have patched together systems internally, adapt to the new operational standards being developed?
DeAngelis: Smaller managers fit in with a trend we're seeing of outsourcing operations. To participate in this space, you have to do it cost efficiently, and you need to be competent at running portfolios, as well as be good at sales, marketing, operations and the efficient handling of transactions. Many managers are recognizing that their real value is running good portfolios for clients and that they can cost effectively outsource functions to others with experience.
If you're a small firm, you'd have to think long and hard about doing it all yourself, which is why more and more niche managers are making that strategic decision.
MME: Will service providers need to reduce prices to accommodate smaller managers?
DeAngelis: There are pricing differences now. If there is more volume, there is more efficient pricing.
At the core of it all, all money managers need the same services from providers, which is the best practices, technology and expertise available. If they tried to replicate the same themselves, it would cost them so much more than if they outsourced.
MME: Don't service providers, like PFPC, end up taking the risk that technology implemented today may be outdated in a few years as standards and technology move forward?
DeAngelis: Yes, PFPC takes the risk of outdated technology down the road. This is not a side, little business to get into, the outsource servicing business. PFPC and others provide securities lending, custody and many other services on behalf of customers. That's the nature of the business. But in this way, managers aren't the ones having to take the technology risk, although they are the ones taking on the risk of picking the next stock.
MME: As the managed account industry matures, will we see consolidation among outsource service providers?
DeAngelis: Absolutely. What happens in any niche of a market, is that you need to develop the sophisticated technology to achieve the scale of operations to make a decent profit margin.
In custody and clearing operations, for example, Pershing, National Financial and Bear Stearns altogether account for something like 60% or 65% of the market. They have the technology needed for scale and to realize cost efficiencies. Consolidation is a natural evolution for any type of similar servicing. The winners will be the ones to achieve the level of scale necessary and do this efficiently.
Over time, you will end up with a handful of dominant providers. If this is a side business for an organization, it won't be around long term.
You've already started to see a winnowing out. Look at The Bank of New York, a huge and excellent organization in providing operations and technology. It made the decision recently that separate account servicing no longer fits in with its business direction.
MME: But doesn't fewer outsource service providers mean less choice for money managers?
DeAngelis: Yes it does, but managers will be getting a tremendous value out of those outsource service providers that remain.
MME: How will the shift to standardization of technology affect broker/dealers and investors?
DeAngelis: One of the effects of standardization is that it will create a much easier portability of clients moving from one broker/dealer to another, which can be very good news for clients when they wish to switch.
MME: Beyond the move to standardization, are there other technology challenges being faced by the managed account industry?
DeAngelis: Yes, there are many technology issues still out there. As I said, this is an evolutionary process. But the MMI's operations service committee is comprised of the best minds in the business working to sort through the challenges and the solutions.
MME: Is it just that the industry's workings are ahead of the technology?
DeAngelis: Yes, and that's par for the course. The needs are out there and are driving technology solutions.
MME: What do you believe lies ahead for the industry?
DeAngelis: Next, the industry will need to digest and implement the standards being developed and support the unified managed account (UMA) concept. The real impact of the UMA goes beyond the capacity to mix exchange-traded funds, mutual funds, stocks and bonds and separately managed accounts into single accounts.
As part of that process, money managers and sponsors will see a big shift of both operations and the fiduciary responsibility from the money managers to sponsors and also for portfolio management decisions being taken from the end adviser to the central office of the broker/dealer. That shift will be a lot to digest.
MME: Beyond technology, how do you see products evolving?
DeAngelis: There's been talk of unified managed accounts broadening out to become "unified managed households." While a unified managed account combines all types of investment products within a single brokerage account, a unified managed household would combine multiple brokerage accounts across multiple registrations to include the individual investments of spouses and children, for example, and may expand to allow for multiple relationships across different broker/dealers.
MME: What other changes do you foresee?
DeAngelis: One of the things the UMA concept will bring to the forefront is more transparent pricing.
In the mutual fund world, a wrap fee client sees a 1.5% or 2% fee, but not necessarily a breakdown of that fee. In a UMA, there is a mixing together of different investment vehicles and cost structures. Fee disclosure, such as what the adviser is being paid, what the SMA manager is being paid, what the custody costs or transaction costs are, are being considered in terms of disclosure to clients. I think the industry is going to need to think long and hard before disclosing these fees. Many might be uncomfortable with transparency and its complicated nature.
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