A recent survey of the ultra-high-net-worth, as conducted by the Spectrem Group of Chicago, raises some questions and quandaries for investment advisors who are hoping to entice these wealthiest of investors.

For one thing, it indicates that the mega-wealthy are allocating significant assets to mutual funds, America's investment vehicle of choice, with almost half of U.S. households across all income levels owning at least one.

In fact, according to the Spectrem survey, these investors have doubled their allocation to mutual funds between their sampling periods of the spring/summer of 2003 and January/February of 2005.

Up to 12% in MFs, As SMAs Fall to 23%

In early 2003, the super wealthy indicated that a mere 6% of their portfolio was invested in mutual funds, while in early 2005, that figure was a more significant 12%.

Moreover, the new survey's results show a decline in allocations to managed accounts from 26% in 2003 to 23% in 2005. This may come as a surprise to investment managers, as many have spent significant time and resources over the past few years building separately managed account programs tailored to the needs of the wealthy and emerging affluent.

The survey also shows that alternative investments have fallen a bit out of favor, as have individual stocks and individual bonds, while cash deposits have notably increased from 9% in 2003 to 13% in 2005.

This survey, which Spectrem regularly conducts about every 18 months, queries individuals with a net worth of $5 million or more (excluding the value of their primary residence) as to their current investment allocations. This year's 12-page survey included responses from 500 individuals.

No Caution to the Wind

"Investors are being cautious and likely choosing cautious vehicles, including short-term and Treasury mutual funds," said George Walper, Jr., president of Spectrem Group, in an interview. They are also plowing back into stock funds. The current two-fold increase in allocations to mutual funds versus 2003 also shows that for investors, the market-timing scandal "is no longer a top-of-line concern," he added.

Spectrem's earlier 2001 survey, taken in the midst of the three-year bear market, indicated that at that time, mega-wealthy investors had allocated a healthy 11% to mutual funds. But by 2003, likely roiled by the then-lingering bear market, investors had pared back their fund holdings to 6%, Walper explained.

So why have mega-wealthy investors beefed up investments in mutual funds which have become, to some degree, the most loved investment vehicle for the middle class, while seemingly turning their backs on managed accounts?

"It's not that people took money away from managed accounts, they just didn't put more money there," Walper said.

Affluent on a Roll'

"We are a bit surprised by the [Spectrem Group's survey's] declining numbers," confessed Chris Cosentino, a spokesman for the Money Management Institute, which, based in Washington, serves as the national trade association for managed account providers.

Cosentino noted that managed account assets have been increasing 15% year over year, and have seen growth in all of the managed account channels, although the Money Management Institute's sweet spot is the slightly less affluent $3 million to $5 million range, he acknowledged.

Highly Prized IRAs

In fact, the largest growth area for managed accounts in general over the last 18 months has been in the highly prized IRA rollover market, Cosentino said. Many affluent investors are contending with hefty balances of upwards of $500,000 from their 401(k) plans and have been rolling them into separately managed IRA accounts, he added.

"We continue to be on track to reach $1.5 trillion in managed account assets by 2011," MMI's spokesman reiterated.

But there is some debate as to precisely where those beefy rollover assets are finding a new home.

Wrapping It Up

For a 50% Share Lockup

According to Cerulli Associates of Boston, as of the fourth quarter of 2004, 52% of the new assets flowing into mutual fund advisory programs (also known as mutual fund "wrap" programs) came from IRA rollovers, as investors of all income levels transferred money out of qualified retirement plans.

In fact, Cerulli's research seems to back up Spectrem's. In a report released a few months ago, Cerulli found that mutual fund advisory programs are one of the fastest-growing sectors of the investment management industry, even though this sub-sector still represents only 4% of all long-term mutual fund assets.

Assets in mutual fund advisory programs, in which several different mutual funds are combined to provide the client with a diversified portfolio, at year-end 2003 had a collective $178 billion, but had grown to just shy of $235 billion by year-end 2004.

While Cerulli makes no distinction as to the preferences of any one demographic group, the increasing interest in mutual fund advisory programs, for some time now, has been driven in large part by the change from transaction-based commissions to ongoing fee-based advice.

What's more, program veterans, including American Express Financial Advisors, Fidelity Investments, SEI Investments and LPL Financial, have now collectively wrapped up almost a 50% market share lock on the mutual fund wrap industry.

While no one is contesting the Spectrem Group's survey results, the data is downright puzzling for those trying to provide appropriate investment portfolios for the wealthy.

Just what do the very rich really want? And are they, as Ernest Hemingway so famously wrote in The Snows of Kilimanjaro, so very "different from you and me?"

"Given the bad press that funds have had over the past few years with high fees and market timing, it's really hard to believe there's a wave of ultra-high-net-worth investors embracing mutual funds," commented Dorsey Farr, vice president and director of asset allocation for Wilimington Trust in Wilmington, Del.

One explanation could be that the increase in mutual funds as an asset class is predominantly due to the increased use of exchange-traded funds (ETFs), experts told MME. The Spectrem survey does not distinguish between ETFs or actively managed mutual funds, but rather combines them into the same "mutual funds" category.

"ETFs have really boomed in the past couple of years and are probably playing a significant role in the jump in mutual fund allocations," Farr said.

ETFs are definitely contributing to the rise in overall fund assets, agreed Nancy Smith, managing director of Glenmede Trust in Philadelphia. Data from Lipper of New York shows that almost 17% of the $112.9 billion of assets flowing into equity funds year-to-date through June 30 were funneled into ETFs.

In many cases, the super-low expense ratios of ETFs have trumped popular index mutual funds, and even wealthy investors are in favor of cost savings, Smith noted.

Still Most Preferred

In addition, for those who want exposure to international or emerging markets, mutual funds are the preferred investment vehicle for most investors.

"These are hard to do cheaply in a separate account unless you use ADRs [American Depository Receipts]," she said. "Custody is more expensive and you have to deal with currency exchange" within these markets if utilizing a separate account.

"Most individuals prefer to do their investing in international markets through mutual funds," confirmed Paul Gordon, managing director and head of the wealth advisory group at Bank of New York.

"Separately managed accounts are predominant in the large-cap domestic equity categories," Farr noted. But as wealthy investors have done well and broadened their asset mixes into international markets, REITs and even small-caps, "they may have found that mutual funds are the more familiar choice and that the only way they can access these areas is with a co-mingled vehicle," he added.

Money's Worth

While the wealthy tend to be willing to pay more if they get more, they also want to get their money's worth, said Patrick Byrne, president of Aspetuck Financial Management of Westport, Conn. "With the typical equity SMA posting total expenses, including the advisor's fee, of approximately 202 basis points, it's harder to outperform the market with a high-cost structure."

The focus on mutual funds seems appropriate, said Tom Kochis, president of Kochis Fitz, a San Francisco-based financial planning firm that caters to the ultra wealthy.

"People are coming to the realization that beating market averages is very, very daunting, and the costs can be substantial." Still, Kochis added, there are some very important places where separately managed accounts make more sense.

(c) 2005 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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