A three-year bear market has left wealthy investors groping in the dark, but with plenty of cash still sitting on the sidelines separately managed accounts may serve as a beacon of hope for recovery.

A research report issued by TowerGroup, a Needham, Mass.-based research and advisory firm, suggests that SMAs will become the predominant form of equity investment for the next five to seven years given their tax efficiency, direct ownership and customization features. However, it will take time before money will flow back into the markets because of the massive damage that has been done both monetarily and psychologically. The first step is to assess what went wrong with the markets in the first place that forced investors' cash back under the mattress.

Tower attributes it to the "irrational exuberance" that swept Wall Street during the bull run of the late 1990s. The phrase, first coined by Federal Reserve Chairman Alan Greenspan in 1996, describes investors' tendency to believe the hype being funneled through research analysts and the media while ignoring fundamentals. As a result, stocks came crashing down with technology issues taking the brunt of the blows. The report said that the swoon in stocks was marked by three distinct conditions: a fragile economy that failed to recover, a crisis in corporate governance and geopolitical instability and uncertainty.

Given that backdrop, the nation's wealthiest investors took it on the chin with the 15 richest individuals losing $64 billion from August 2000 to August 2001 and 50 of the richest individuals together lost more than $44 billion in August 2001 alone. These enormous losses have forced investors to favor cash and cash-equivalents such as checking accounts, money market accounts and savings accounts. In the period from 1998 to 2003, the assets in those zero-maturity accounts soared from $3.6 trillion to $6.2 trillion, representing a 72% compound growth rate. That $6.2 trillion equals the total number of assets that currently reside in all mutual funds, according to Tower.

The fallout from the market's decline is that investors' trust in their brokers and fund companies has sunk to an all-time low. Many individuals are simply not playing the market. "Neither the industry nor the investor can forget the recent market trauma," said Dennis Ceru, director of retail brokerage and investing at Tower. "Today brokers and investors struggle to understand each other again as they seek some shared belief and attempt to revitalize a scarred value proposition."

The one area that Tower sees money flowing back into the markets right now is in retirement investments such as 401(k) plans. Let's face it. Retirement isn't going away. Dollar cost averaging and small payroll deductions continue to force the American worker to save and invest their money.

Ceru stressed that the business is no longer about gatekeeping information, high-priced commission trades, pushing IPOs, or promoting whatever the firm holds too much of. The focus has shifted to listening to clients. Eventually, money will flow back into equity markets and Tower believes that the best opportunity for individual clients will be through separately managed accounts.

"Properly managed SMAs offer the individual investor choice, tax efficiency, access to professional money management and risk management in a way that direct individual ownership of equities and mutual funds do not," Ceru said. While many market soothsayers have been advocating gold, real estate and debt elimination as safe harbors for cash, most Americans find those options not to their liking, he noted.

Tower believes that SMAs will grow at a compound annual rate of 18.5% over the next five years, boosting assets from $399.7 billion in 2002 to $1.105 trillion in 2007. With that kind of growth, money will move from the sidelines and back into U.S. equities and the U.S. economy, the report said. But in order for that to happen the covenant of trust between broker and investor must be rebuilt.

"Investors want to believe," Ceru said. "The securities industry just needs to give them back good reason to believe."

Copyright 2003 Thomson Media Inc. All Rights Reserved.

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