Stop Wasting Wealth in Mutual Funds Don F. Wilkinson

ASSET MANAGEMENT BEYOND MUTUAL FUNDS
Let Don F. Wilkinson introduce you to a better way of investing your money today: a separately managed account.

Frequently Asked Questions

Most of your concerns about separate account management are explained. If you have other questions or comments, contact us by E-mail at: dfw@wastingwealth.com.

Explain in simple terms: What is separate account management (SAM)?

Individual securities owned directly by an investor that are professionally managed to achieve higher performance, lower fees, increased tax efficiency, and heightened asset control. These and other features provide substantial advantages over mutual fund investing. Who is investing in separate accounts? In decades past, separate accounts were the asset management strategy of choice for institutions and wealthy investors with $500,000 or more in investable assets. Today, it’s a new ball game caused by computer platforms and technology improvements providing separate accounts to investors with minimums of $100,000. This means over 37 million U.S. households qualify. Many high net worth clients are jumping ship from mutual funds. Separate accounts grew by a whopping 29 percent during three quarters of 2000. By the same token, mutual funds grew only 5.2 percent during the same timeframe.

Why should I switch from mutual funds to a separate account?

Mutual funds have served their time well and will continue to do so for those individuals with modest funds to invest. But for the affluent individuals who sweated through the year 2000 when the average mutual fund decreased in value and increased in capital gain distribution—it was a wake-up call. The years 2000-2001 buried a lot of the gains achieved by investors in mutual funds during the 1990s. Therefore, separate accounts— with the benefits of tax efficiency, asset control, customization, lower fees, and services of a professional money manager—offer the knowledgeable investor all that mutual funds once promised but failed to deliver.

How much upfront capital is necessary to establish a separate account?

For the most part, a minimum of $100,000 of investable cash and/or securities is necessary to establish a separate account. However, there are available accounts per asset class minimums in the $25-50,000 range. Low-end separate accounts (folios) are available through Internet financial companies offering lower minimum and lower fees. These usually do not include a high-end money manager.

How much will I pay annually to have a separate account?

Unlike mutual funds with numerous fees and charges, you will pay one straight fee for the serving of your separate account. Expect to pay between 2 and 3 percent of total assets managed annually. But the situation is fluid and the fee often is reduced through discounting and the size of the account. Discounts can be as much as 25 percent and can be even higher with more assets invested. What you receive for a straight-down-the-line fee structure is trading, money management, custody and consultation, plus the benefits of the separate account infrastructure: tax efficiency, potentially higher performance, customization, etc. If you chose not to employ an investment advisor as your advisor, you could bring your annual fee to approximately 1 percent of your separate account total assets annually.

Where do you find separate account management programs?

As you might guess, the big stock brokerage houses—Salomon Smith Barney (29 percent), Merrill Lynch (22 percent), Morgan Stanley Dean Witter (10 percent), Paine Webber (9 percent), and Prudential (8 percent)—hold most of the separate account business. However, the regional brokerage houses (Raymond James, AG Edwards, Wheat First Union, etc.) are coming on strong and lock in 14 percent of the business. The final 8 percent is a mixture of financial service firms like banks (Wells Fargo, Chase, etc.) and independent broker/dealers (American Express, etc). These percentages will change as the big mutual fund houses (Fidelity, Oppenheimer, MFS, etc.) are scrambling to bring out their own managed account programs. All in all, the industry is expected to experience a 30 percent yearly growth reaching one trillion dollars in 2005 (Financial Research Corp, FRC).

What should an investor watch for in setting up his/her separate account?

If you read the previous question, do your separate accounts due diligence very carefully. With the truckload of vendors including broker/dealers who sell through independent investment advisors, banks, insurance companies, mutual fund companies, regional brokers and the national wire houses such as Salomon Smith Barney, it will pay you to check carefully before you make the plunge into separate accounts. There are more choices, control and prices for separate account management than ever before. No matter if you are going it alone or utilizing a financial advisor, make your move wisely.

How do separate accounts work?

Understanding the financial landscape of separate accounts means understanding who the players are. One of the major reasons to establish a separate account is access to the services of a money manager who otherwise would not be obtainable with earlier investment funds. These money managers manage your portfolio on a daily basis to make prudent investment decisions. The investor still retains control of his portfolio, even hiring a financial planner to function as a consultant to assist the investor in making rational investment decisions. If you decide not to hire an investor advisor, then you will function as your own consultant. All in all, a separate account program includes the program sponsor (brokerage firm, etc.), money managers, and the financial advisor (if selected), assisting the investor in enhancing his or her portfolio.

Who determines the asset allocation in setting up a separate account?

First things first. You initially review your complete financial picture—goals, investable funding, performance requirements, time horizon and tolerance for risk. This process is typically accomplished with a financial planner but you can go it alone. What should come out the other end is your investment policy statement, which is shared with your money manager and sets in motion your asset allocation between asset classes. Your investment policy statement is designed to keep you, your financial advisor, and your money manager(s) on track with your asset mix. Usually a separate account has only about 50 stocks versus up to 150 stocks in a typical mutual fund. Institutional money managers have as many as 15 advisors doing stock selection for 50 stocks versus one manager selecting 150 stocks in a mutual fund. Feel free to alter your plan as you go because you, as the investor, are in charge of your portfolios. However, your money manager(s) and investor advisor will be there to provide the necessary advice to reduce the emotional second-guessing from investment decisions.

How do I handle my taxes if I purchase a separate account?

Unlike mutual fund investors, separate account investors hold stocks in their own name. In mutual funds, investors are shareholders and have no control over the taxation of their funds. At the end of the year, new shareholders have to pay taxes on the same capital gains as investors who have been shareholders since January 1. Separate account managers do “tax harvesting,” offsetting gains with losses to deliver a higher after-tax return than mutual funds for their clients.

How do clients track their separate accounts?

What your money is doing is never more than a click away. The Internet makes it easy to check on your separate account regularly and make investment decisions as need be. Your investment advisor and money manager, depending on the program, are usually a phone call away. You will receive full reports on investment activity usually quarterly. How does the future look for separate accounts? It does not appear that the big leap from mutual funds to separate accounts in 2001 will falter. Cerulli Associates, the Boston firm specializing in researching the separate accounts industry, says separate accounts will average 30 percent growth per year with assets building to $2.6 trillion by 2010. Does this remarkable growth leave the mutual funds industry in the dust? No one knows for sure. The separate accounts process gives upscale, knowledgeable, take-charge investors access to the cream of the crop institutional money managers, a better way to manage taxes, and more control over their investments. This is why they are calling it the separate accounts revolution!