Separately managed accounts have enjoyed tremendous growth in recent years as high-net-worth individuals have been lured by their direct ownership and tax management features. Nowhere in the asset management industry has that growth been more evident than at Jersey City, N.J.-headquartered Lord Abbett, a well-established partnership with $49 billion in assets.
Under the leadership of Mark Pennington, partner and director of advisory services, the firm has taken the managed account world by storm. Armed with a unique strategy of combining a small number of sponsor relationships with a seasoned sales force, Lord Abbett has risen from $3.6 billion in separate account assets at the end of 1999 to more than $14 billion at the end of 2003.
Money Management Executive Associate Editor Kevin Burke recently spoke with Pennington about putting together a successful SMA program and what challenges lie ahead for the industry.
MME: What challenges are you currently facing in presenting separately managed accounts to clients?
Pennington: Right now, there's little customer pull. People are not coming into financial consultants and saying, "Give me some of those separately managed accounts." If you go back three years ago, when the market was booming, people were either trading on their own, or they were going to their financial advisors and saying, "Put me in this Internet fund or I'm moving my account."
If you look at some of those day-trading strategies where investors were chasing what looked like the Holy Grail of their investment future, it turned out that greed was probably driving that investment decision. The flip side of that right now is you have people putting their money in short- term fixed income, or even remodeling their home because real estate is doing so well. Those strategies really are based on fear. Fear and greed are the two largest-driving forces for individuals making their own investment decisions. And investors acting on those emotions typically tend to be doing the wrong thing at the wrong time.
MME: What investment styles are the biggest sellers right now?
Pennington: I would guess growth and value in stocks and bonds, but I couldn't confirm that. You would have to go to a sponsored firm to get that. I know our flows have been incredibly strong. We've had a very robust business in the separate account space. If you go back to September of 1999, we were at $3.6 billion in assets. Now we have over $14 billion in assets.
MME: Who are your typical managed account customers?
Pennington: It could be a person with $1 million to $1.5 million in investable assets, probably 50 to 60 years old with a longstanding relationship with their financial adviser. The minimum account balance at Lord Abbett is $100,000. There are a few exceptions out there, but typically $100,000. Basically, what you need in the separate account space in order to get the adequate diversification with $100,000 minimums is to put at least $500,000 at those minimums to get properly diversified. So, if you have someone with a net worth of $1 million to $1.5 million and they have $500,000 dollars in investable assets, that would be a decent profile.
MME: What would you say is the sweet spot for the SMA business?
Pennington: Well, remember that we are probably a part of an asset allocation. Some people choose to put all their money with us, but I think a lot of people in an open-architecture environment would give a portion of their assets to us. If they hired three or four managers, we would expect to get one-third to one-fourth of that $500,000 to $1.5 million. That's what I would say would be the sweet spot.
MME: How is your firm trying to service the customer differently from your competitors?
Pennington: Our strategy has been a simple one. We want to make a lot of difference to a few people rather than a little difference to a lot of people. We really only embrace sponsor firms that want to approach this business as a client solution versus just another product to sell to their clients. And so what we've done is worked with just eight different sponsor firms, whereas the average manager has 31 relationships. We also have the largest sales force of any manager in the separate account space.
Think of it as three legs of a stool. We have 55 regional managers in the field and 11 portfolio specialists who are intimately familiar with the portfolios. At a moment's notice, they can conduct a conference call or presentation for a client at a portfolio level. The second leg of the stool is education. We put a lot of time and effort into CIMA (certified investment management analysts) education for our regional managers to make sure that not only are they out talking about how we run our business, but also can help the broker work with the investor as a true consultant.
The third leg of the stool is client acquisition. A number of consultants have asked us to help bring them new clients, so we created a system called "Lord Abbett's Intelligence." It is a Web-based tool that provides detailed information about current clients and helps find information about prospects, whether it's foundations, small business or 401(k) plans.
MME: Are there aspects of your business that you think can be improved?
Pennington: In the last four years, we have gone from not even being on the radar screen to being the second-largest manager in the space. Some of the concerns I have going forward with the immense amount of success and account volume growth that the industry has seen is, will the industry end up collapsing under its own weight because of the operational infrastructure needs that are out there? Some of the big things that we need to work on going forward are making sure we have some solutions to those operational complexities as the business grows.
In 1986, the mutual fund industry implemented FundServe, which was an industry solution that helped the processing of trades. By coincidence, the mutual fund industry was $400 billion in size in 1986. Well guess what? The SMA industry, which is roughly $400 billion, is starting to have some of those conversations today.
MME: You mentioned the industry "collapsing under its own weight." Can you explain what you mean by that?
Pennington: The separate account space is customizable, individualized, and clients own the individual securities. So, for example, we have $14 billion in 54,000 accounts, and we've got the infrastructure and systems in place. But as we continue to grow, instead of just hiring more bodies, is there a way systematically that the automation and technology can help us build a solution? It's those types of things that standardization might really help solve.
MME: Can you explain the importance of client support to your business and the industry as a whole?
Pennington: I can't speak for every manager, but one thing we do at Lord Abbett is we look at things from a customer standpoint, truly managing accounts on an individual basis and recommending what is right for them.
Let's say we are working with a small business owner, and we realize that working with the consultant, that business owner did not have a 401(k) plan. It would make sense for the customer in terms of their employees reaching their retirement to have a retirement plan. So we would work with that consultant and implement maybe a safe harbor 401(k). In the implementation of that safe harbor, a mutual fund probably makes the most sense from an efficiency standpoint with a lot of small holdings.
Then we find out that that business owner that used mutual funds to start the 401(k) has $1 million in taxable assets and wants to be able to do some tax management to their portfolio. Maybe an SMA makes more sense.
MME: What is your outlook for firms that are trying to enter the business right now?
Pennington: The separate account business is incredibly manually intensive, the margins are a lot thinner, and if you are going to enter into the business, you need to be ready to commit to it for the long haul. You have to realize what you are getting into, due to the complexities involved.
MME: What do mutual funds seeking to enter the SMA space need to do to compete successfully?
Pennington: You have to be a firm that centers on investment management, and you've got to make sure that whatever process you are using, you stick to the integrity of that process. Unless you have the field force out there that is smart, it will be hard to get shelf space. So a firm has to have a great investment track record, sales and marketing prowess and strong client service.
MME: Minimums have been trending downward in recent years. How does that affect your business?
Pennington: The right approach would be to bring the minimums down not because we want to sell, but to aid in diversification. I don't want to take an account below $100,000 if I'm a one-trick pony. What I want to do is take the under-$100,000 account if I'm part of an asset allocation that will allow the client to reach their investment solution. And if they have a positive result or a good experience, then the assets will be stickier.
MME: Some observers have complained about the retailization of hedge funds, with their minimums coming down, saying that this adversely exposes retail investors to more risk. Is that something you see happening in the SMA industry?
Pennington: It's like anything else. You can't have too much of a good thing. You have to be well balanced. Lower SMA minimums are fine as long as a manager can oversee the account well and get the proper diversification. And that depends on different accounts. Our minimum account size on municipal bonds is $250,000. Yet, we have taken, in certain circumstances, a $50,000 account on large-cap value. In such an account, I try to have 62 securities in the portfolio and make sure that I'm properly diversified, and I can do that at the $50,000 level. But we can't do that with municipal bonds. So, it's a discipline-by-discipline decision.
MME: What is your biggest fear or concern going forward in the SMA space?
Pennington: I would probably have to say the infrastructure of the industry and making sure that we achieve healthy growth. We must take the necessary steps to ensure that it grows to be a $2 trillion to $3 trillion dollar industry years from now, which we believe it will.
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