Internationally, separately managed accounts are growing at a steady pace, unlike the leaps and bounds their stateside counterparts are experiencing.
Money Management Executive Associate Editor Chris Frankie recently spoke with Shiv Taneja, a London-based senior analyst with Cerulli Associates, about why Cerulli projects these growth rates to continue, the differences in SMA products worldwide and the thinking of the non-U.S. investor. Taneja also explained how U.S. asset management companies have been able to expand their SMA products abroad and which corners of the world present the greatest opportunities.
MME: What is the main difference between the separately managed accounts business in the U.S. and in the international community?
Taneja: A lot of people in America get a sense that SMAs are similar internationally, but they are as different as they could possibly be.
One of the main differences is that SMAs in the U.S. grew in a linear way. Each product grew in an individual, independent silo. We're now seeing some degree of unification in the U.S., with crossovers between mutual funds and separate accounts. Internationally, firms have been offering unified managed account programs that combine the products.
Second, in the U.S. there's a huge development of separate accounts. Internationally the focus is much more on mutual fund-based programs.
The third point of differentiation is in the U.S. where there's a lot of emphasis on customization. Although there is a lot of cachet placed on the ability to customize separate account programs, the reality is no more than about 30% to 40% of the programs in the U.S. are actually customized.
Investors in Europe, and to a lesser extent in the U.K., are less focused on this issue of customization. They are far more focused on tax protection because tax rates across the Continent and in the U.K. are fairly high, so people are looking for ways to protect their investments, usually through a tax wrapper. It's a cultural thing as much as it's a practical thing. Mutual funds provide far more protection and far more tax deferral than separate accounts.
The other thing to bear in mind is the U.S. separate account business has been very much dominated by the wirehouses or the brokerage firms. Internationally what we've seen is that's not the case at all.
MME: What's the role of unified managed accounts in the marketplace?
Taneja: A unified managed account simply put is a program that includes both mutual funds and separate accounts. Conceivably, you could put anything else in there that you like, such as ETFs or hedge funds. It's pretty scalable in terms of what products could go within the construct of the unified managed account.
In the U.S., the development of separate accounts came very much in the context of institutional management - where managers were picked for specific areas of expertise. For example, you picked by style. Internationally, none of this really exists. In an international environment you would typically have a global mandate, so it cuts across all the various styles. The U.S. approach of building a unified managed account based on style has no resonance internationally. We just don't differentiate on the basis of value and growth.
In the U.K., for example, which is probably closest to the U.S. model, many firms have tried to develop the style concept here, value and growth, but to be honest, it just hasn't worked.
MME: In a recent report, Cerulli asserted that the SMA industry outside of the U.S., which was $260 billion at the end of last year, will grow to $390 billion by 2007. Meanwhile, experts are predicting the U.S. industry will jump to more than $1 trillion in that time frame. Why is the product expected to be so much more popular in the U.S.?
Taneja: There are several issues. One is the fact that managed account programs have existed in the U.S. for 25 years. There's a certain history, a certain understanding there.
The U.S. is finally coming to grips with technology. That's an absolutely crucial element of the development of separate accounts. How do you go and create the requisite hardware to develop or to produce a labor-intensive managed account program and keep it at a fairly low level of cost, given that average account sizes are falling rapidly? That's something we haven't even begun to consider in the international marketplace.
There also is a strong rationale, particularly from the separate account standpoint in the U.S., of taxation. The ability for a separate account to provide the investor with the capability to manage his or her tax liability is seen as a big advantage in the U.S.
Also, it's very difficult and very expensive in the international marketplace to launch a program that you can distribute and sell across multiple markets. Forget about the language issues and the currency issues and all that, there are very few organizations that even have the footprint to distribute in multiple marketplaces.
MME: In the report, Cerulli says that large U.S.-headquartered financial firms represent the main thrust of international managed account development. Why do you think this is?
Taneja: U.S. firms understand the business, have made the investments and have done the due diligence.
The successful U.S. programs are the ones that have big existing international operations already and are able to customize their U.S. programs to take into account the various differences of the international marketplace and tailor products for each nation.
MME: Where do you expect separate accounts to see the most activity?
Taneja: In terms of separate account development, I would say the U.K., Canada and Australia. In terms of mutual fund-based managed account programs I would say again the U.K., to some extent, and definitely Continental Europe.
The Canadian market is very similar to the U.S. market with the exception that, historically, managed accounts came out of the banking channel as opposed to the brokerage channel. Most of the managed account activity comes from brokerage firms akin to the U.S.
In Australia over the last six months or so, we've seen one or two programs launched. The Australian market is a small market but very sophisticated. It's an advice-rich market, very much driven on a highly complicated tax structure.
The third market is the U.K. It is an interesting market because it has a lot of historical assets, which are managed by what we call private clients, stockbrokers and asset managers. These are more affluent brokers, or brokers who manage the money for more affluent investors. There's about $300 billion dollars. Assuming even a small share of that migrates to managed accounts, then we're expecting $30 billion to $35 billion by 2007. And potentially a large portion of those assets could be managed as separate accounts.
MME: Cerulli also said it expects the Australia/Asian region to only hold a 4% market share of the SMA industry outside of the U.S. by 2007. Why are the projections so low for this region?
Taneja: Asia as a whole is a very large continent with two of the largest countries in the world, but from an asset management standpoint, it's a pretty small market. If you look at just the retail marketplace, Cerulli doesn't expect the Asian retail asset management market to hold more than $500 billion, excluding Japan, by 2007. In itself, that's a large number, but it's only the size of France today.
We could spend all our time talking about the great potential of Asia, but the truth of it is these markets are relatively small. Japan is a very, very large domestic market in itself, but a conducive market for managed accounts doesn't exist there yet. Japan, like some of the other Asian countries, is a pretty insular country.
Australia holds some pretty exciting potential for the development of managed accounts. The tax structures are pretty similar to that in the U.S, and they look very much to the U.S. for developments. For the rest of Asia, I think it's still relatively early, but watch this space. It's a big region, and over a period of time we will see some growth there.
MME: Hedge funds have been gaining in popularity in recent years. It would seem logical they would be competing for the same clients as SMAs. Is this the case?
Taneja: I have always believed that hedge funds would be a perfect complementary strategy within a managed account program. So, if you just think about a unified concept where you hold long-only shares or long-only mutual funds and you are looking for a hedging strategy within that, a hedge fund or fund-of-hedge funds within a managed accounts construct makes a hell of a lot of sense. I would actually see it as complementary to the development of a managed account program.
I don't think they are competing for the same money because they serve two completely different needs.
MME: What are the main hurdles to growth of SMAs going forward?
Taneja: I think the key issue in Europe, Continental Europe and some parts of even Asia is tax. It is unappealing to be in a separate account in Europe because every time you trigger a capital gain or a capital loss you have to take a hit on it. Within a mutual fund you don't take a hit on it unless you exit the mutual fund. So, you get a tax deferral on it, and that's a huge incentive.
MME: While the U.S. marketplace is expected to continue its remarkable growth, what can we expect from the rest of the world?
Taneja: Managed accounts in the international marketplace are not going to explode. They're not going to suddenly become the most exciting thing since sliced bread. It's a slow, evolutionary process. We're going to see pockets of it develop. We will see lots of people try to get into it but then not have the stomach for it. So, there will be lots of failures along the way.
Clearly, if we have this conversation in five years' time, I will come back to you and say we have seen some pretty amazing things happen over the last three or four years. But, they're going to happen slowly and in a fairly muted way. But they are going to happen.
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