In the not-too-distant past, the bank brokerage industry wasnâ€™t much of a threat to Wall Streetâ€™s aggressive pursuit of high net worth individuals. Most bank-based brokerage operations had pretty limited offerings (mutual funds, annuities, and insurance) and usually the banks didnâ€™t venture far from their own proprietary products.
â€œThe banks would try to get deposit dollars into investments, but it was piecemeal,â€ says Jeff Strange, a senior analyst with Cerulli Associates in Boston. Their frustration was that they didnâ€™t have anything â€œholisticâ€ to offer - â€œa way to deliver investment advice,â€ he says. But the banks are now becoming serious competitors in one of Wall Streetâ€™s long-established and more sophisticated lines of business: â€œManaged Account Solutions,â€ the umbrella term for separately managed accounts (SMAs) and mutual fund wrap programs.
The charge is being led by some of the biggest names in banking â€“ Citigroup, Wachovia, Wells Fargo, and PNC â€“ and many of the banks that arenâ€™t big enough to build their own platforms are getting into the game by signing up with third-party providers.
â€œThe big players are always the pacesetters, but all the banks want to learn how to do this business,â€ says Christopher L. Davis, the president of The Money Management Institute of Washington, D.C., the national organization for the managed accounts industry. â€œThey have to, or theyâ€™ll be left behind, and they know it,â€ he says. SMA programs give individual investors their choice of a variety of independent money managers â€“ managers whoâ€™ve built their track records by managing institutional money - while mutual fund wrap programs give investors the same kind of choices by offering funds from a number of sponsors. Some accounts include both SMAs and mutual funds from third parties, and some include other kinds of investments such as individual stocks and bonds or ETFs. By now, the range of options is pretty wide and getting wider.
But, whatever the mix of investments, every managed account program starts with a suitability analysis and a coherent asset allocation structure, and includes other portfolio services such as automatic re-balancing and consolidated performance reporting.
What a lot of clients are seeking is that structure, the bankers say.
â€œA lot of our clients have gradually accumulated assets like stocks or mutual funds in an IRA, and all of a sudden, theyâ€™ve got $100,000 or more, and they realize that maybe thereâ€™s a better way to manage that money in a portfolio thatâ€™s got some structure to it,â€ says Mark Hubbert, the chief operating officer for Wachoviaâ€™s bank brokerage unit, the Investment Services Group. He estimates that probably more than 50% of ISGâ€™s managed accounts hold retirement assets. (Wachovia is a hybrid, with both a bank brokerage and a full-service brokerage, and it offers the same managed account solutions on both sides of its business.) Meanwhile, PNC of Pittsburgh has been scoring a â€œhome runâ€ with its new Capital Directions mutual fund wrap program, says Mike Mortensen, the president and CEO of PNC Investments. That program has been, â€œpulling in about $50 million in new assets every month, and for a company our size, thatâ€™s a lot of assets,â€ adds Mortensen.
Introduced in 2004, PNCâ€™s Capital Directions program had $1.2 billion in assets under management as of year-end 2006, almost twice its year-end 2005 total of $651 million, while the number of accounts grew to 11,700 from 6,696 year-over-year â€“ a 74.7% increase. â€œApproximately half of our new assets are going into the wrap product,â€ he says; â€œ[The growth has been] sustained, steady, positive, with very little attrition.â€ When asked what they like about the program, clients cite â€œprofessional money managementâ€ and â€œthe software that tells them whether theyâ€™re on the right path towards meeting their goals.â€ Mortensen also says that it puts the bankâ€™s advisors â€œin a more advantageous place, where instead of talking about a chunk of money due today, theyâ€™re able to focus on more fundamental needs like retirement planning.â€
In the context of PNCâ€™s program, â€œprofessional managementâ€ means an open architecture platform, with mutual funds from seven different sponsors, six of which are independent of the bank - American Funds, Fidelity, Federated, Eaton, Oppenheimer, and Putnam - as well as Blackrock, the asset management firm where PNC has a 34% ownership interest.
These days, the banks are where the exciting growth is, says Davis; â€œHere at MMI, weâ€™ve focused on the bank channel for the past four years because we see bank brokerage as a relatively fast-growing distribution channel.â€
The big wirehouses â€“ including Merrill Lynch, Morgan Stanley, and UBS - still dominate the industry, with $631.7 billion in SMA assets under management as of the third quarter of 2006, according to Dover Financial Research of Westwood, MA., which compiles the MMIâ€™s statistics. That represents 78.4% of the industry total of $805.8 billion.
By comparison, as of the third quarter, the banks were still a distinct minority, with $65.3 billion in SMA assets under management and an 8.1% share of the market, according to Dover. But the same source indicates that the banksâ€™ market share has been growing steadily â€“ from $47 billion, or 7% in 2005, and from $30 billion, or 6% in 2003. The banks are now the second-largest segment in the industry, ahead of the regional and independent brokerage firms.
Doverâ€™s research also shows that the two 800-pound gorillas of the marketplace are Citigroup and Merrill Lynch. Citigroup has nudged out Merrill for the No. 1 spot in MMIâ€™s Top Ten list of SMA sponsors, with $206.6 billion in assets under management as of the third quarter and a 30.7% market share, versus $156.8 billion in assets under management at Merrill, which was No. 2, with a 23.3% market share. Bank of America, a relatively new entrant, was No. 7 on that most recent list, with $20.5 billion in SMA assets under management and a 3% market share.
Citigroup includes both Citicorp Investment Services (its bank brokerage operation) and Smith Barney (its full-service brokerage division), both of which have had their own SMA and mutual fund wrap programs for many years â€“ Smith Barney since 1973. The two divisions are about to be more fully integrated this spring, in part so that Smith Barney can include basic banking services as part of its offerings to its brokerage clients, in the hope of increasing customer loyalty.
The bank side of the operation will also be getting Smith Barneyâ€™s latest managed account product, called â€œSelect Portfolios.â€ Launched in April of 2006, Select Portfolios is a next-generation SMA product â€“ whatâ€™s called a â€œmulti-discipline accountâ€ or MDA. This type of managed account is also known as a â€œmultiple strategy portfolio,â€ says Jim Tracy, the director of Smith Barneyâ€™s Consulting Group, the division thatâ€™s in charge of the brokerageâ€™s managed money products and services.
The advantage of this type of SMA account is that itâ€™s â€œmore streamlined and simplerâ€ because it â€œutilizes multiple asset classes and managers in a single account,â€ says Tracy. (With a traditional SMA program, a client has to open multiple accounts if he or she wants multiple strategies, the MMI says in its background information on the different kinds of accounts that are available throughout the industry.) â€œSince April, weâ€™ve raised about $2.1 billion [through Select Accounts], and thatâ€™s all on the Smith Barney side, but this program will be available in the consumer bank,â€ Tracy says.
â€œWeâ€™re seeing clients of all types and sizes invest in Select Portfolios â€“ some have in excess of $30 million, and some have [the minimum of] $100,000.â€ The reason the program is able to span such a wide gamut is that it includes tax overlay management features that are, according to Tracy, â€œvery, very attractive to high net worth clients that have specific tax issues in life,â€ but on the lower end, it gives investors a â€œprofessionally managed, diversified pool of assets in multiple asset classes â€“ small cap, mid-cap, international, fixed income â€“ all in a single portfolio.â€ Citibank already has about 700 bank-based advisors that are licensed with a Series 7, and that group will be merged into Smith Barneyâ€™s 13,000-plus sales force and will operate under the Smith Barney name. However, theyâ€™ll still be stationed at Citibank branches, says Craig Pfeiffer, executive vice president of Smith Barneyâ€™s Private Client Group, and the person in charge of the integration. As part of the integration, some brokers from the Smith Barney side will be moving over to Citibank branches, he says. â€œThe most important thing,â€ says Pfeiffer, â€œis that the client is going to have a Smith Barney experience in a bank location [that will be distinctly different from] the traditional bank brokerage client experience.â€
â€œThe banks are higher on the curve in terms of getting new assets because separate accounts are newer to them,â€ says Strange. He notes that while the entire managed accounts industry is growing rapidly, the strongest growth is not in SMAs, but in the mutual fund advisory programs, where the minimums are lower â€“ sometimes, as low as $10,000, though Strange claims that the minimums can range as high as $250,000. The mutual fund wrap programs â€œcater to a wider spectrum of clients,â€ he says, and they also get a big share of the IRA/401(k) rollover market. About half of the new assets that are going into mutual fund advisory accounts industry-wide are retirement assets â€“ â€œa trend thatâ€™s escalating as the baby boomers retire.â€ The mutual fund wrap programs give the banks â€œanother way to deliver adviceâ€ to those people whose assets arenâ€™t large enough for an SMA program, he says.
But it wasnâ€™t the need to upgrade their level of service at the lower end of the spectrum that prompted the banks to finally develop their SMA and mutual fund advisory programs. Rather, what pushed them was that they were losing a large number of clients from their trust departments to the new â€œhigh net worthâ€ divisions launched by the wirehouses. As early adopters of the SMA concept, the full-service brokerage firms were able to attract a greater and greater share of the banksâ€™ wealthier clients by offering them independent managers with more aggressive styles and better returns, which was particularly compelling during the bull market of the 1990â€™s. Meanwhile, most of the banksâ€™ trust departments were still managing their clientsâ€™ portfolios in-house, and typically, their portfolio managers were much more conservative. â€œMost of the banks had their own asset management arms, so they didnâ€™t want to put up an SMA program that brought in competing managers,â€ says Len Reinhart, the president of Lockwood Financial of Malvern, PA., a third-party provider of managed account solutions to financial institutions. Without SMAs, he says, the banks were at a â€œfairly substantial competitive disadvantage with the higher end of the marketplace - $500,000 and up.â€ That institutional resistance to change cost the banks a lot of business. A study done by Celent Communications of Boston in 2004 estimated that between 1992 and 2003, the banksâ€™ share of the ultra-high net worth market (defined as individuals with investable assets of at least $10 million) dropped precipitously, from slightly more than 60% to a little over 20%.
â€œThe banks were relatively slow movers,â€ Davis says; â€œIt was only about six or seven years ago that they woke up and saw the flight of capital out of their trust departments towards managed accounts [at the full-service brokerage firms] and resolved to do something about it.â€ Davis notes that â€œwhat they elected to do was to develop their bank brokerage capabilities as a counterfoil to that asset haemorrhage.â€ While the assets were over on the trust side, â€œthe enthusiasm for doing managed account business resided in the brokerage department.â€
It made a certain kind of sense to develop the technology first for the brokerage side, since the software that was created for the smaller accounts could be scaled upwards for the larger accounts that were over in the trust or private banking divisions. However, the opposite wasnâ€™t true. Many of the bank brokerage operations that offer managed account solutions now have minimums that are far less than that old benchmark of $500,000. Though the minimums are lower, and trending downwards as technology brings about greater scalability and efficiency, Davis says that doesnâ€™t mean that the new accounts that are being opened on the brokerage side are necessarily the smaller ones. For instance, in 2002, Wachovia launched whatâ€™s known as a â€œunified managed account,â€ which blends SMAs and mutual funds into one portfolio, and named it â€œDiversified Managed Allocations,â€ with a $150,000 minimum.
The average account size is â€œactually a little north of $700,000,â€ says John MacEleny, the director of product communications for Wachoviaâ€™s Investment Products Group. â€œIt was something that surprised us when we rolled it out,â€ he says. Initially, the firm thought DMA would appeal to â€œclients who were graduating from mutual funds to a separate account solution, but we found that high net worth clients and smaller institutions prefer a simple solution as well,â€ he says, adding â€œIt definitely surprised us as to how up-reaching into the food chain this was.â€ (The DMA account is being offered to all of Wachoviaâ€™s clients across-the-board and not just to its bank clients.)
As of year-end 2006, the DMA program had $12.5 billion in assets versus $8.8 billion at year-end in 2005, a 42.6% increase. Where the DMA program really hit its stride was during 2004, after Wachoviaâ€™s merger with Prudential Securities brought in a new group of full-service brokers who were more familiar with this kind of account. He adds that with time, Wachovia has also been able to broaden its range of investment options. Originally, DMA offered about 19 managers and 30 strategies, and thatâ€™s since grown to about 40 managers and 60 strategies. â€œWe offer everything from domestic equity managers to REITs and converts, and international managers,â€ MacEleny says. Wachovia is now No. 5 on the MMIâ€™s â€œTop Tenâ€ list, with $44.4 billion in SMA advisory assets as of the third quarter of 2006, representing a 6% market share.
Meanwhile, since 2000, Wells Fargo has had a platform that uses both third-party separate account managers and third-party mutual fund sponsors, called â€œWells Selectâ€ on the SMA side and â€œWells Select Mutual Funds.â€ Both have low minimums: $100,000 for â€œWells Selectâ€ and $25,000 for the mutual fund wrap program, says Lidiette Ratiani, the senior vice president in investment consulting solutions at Wells Fargo Bank in San Francisco. She notes that itâ€™s not that investors have to make an either/or choice between SMAs and mutual funds. In the context of the SMA product, an investor can also elect to include some mutual funds to complete his or her strategy, she says. â€œSay you have a portfolio with $250,000, and you have two separate account managers â€“ one, large cap core, and another, fixed income â€“ and then you have $50,000 remaining.You can use mutual funds as a completion strategy, to get some exposure to international or emerging markets, or small caps or high yieldâ€ Ratiani explains. â€œWhat we are focused on in 2007 is building out the other components for a unified managed account,â€ she says, adding that the bankâ€™s goal is to add alternative investments and ETFs to its platform by the fourth quarter.
Wellsâ€™ managed accounts started to take off in the period of time between 2003 and 2006, she says, with a big jump in the amount of assets under management by the end of last year. Ratiani also observes that between year-end 2005 and year-end 2006, assets rose from $4.9 billion to $6.1 billion, for a 49% gain, while the number of accounts grew to about 26,000. Wells didnâ€™t make the MMI list of the Top Ten but going by a different measure, Cerulliâ€™s numbers show that as of the third quarter, Wellsâ€™ managed accounts program had one of the fastest compound annual growth rates in the industry, at 53.6%. One of the reasons why Wellsâ€™ program has been growing so rapidly is that the bank has been moving very aggressively to get its bankers licensed with a Series 7.
By year-end 2006, the number of licensed bankers had grown to 1,451 for a year-over-year gain of 7%, and in 2007, â€œwe expect to grow by 13% and end the year with 1,634 producing licensed bankers,â€ a company spokeswoman said. â€œThereâ€™s a segment â€“ what I call the mass market (for lack of a better description). But people with investable assets up to $100,000 - theyâ€™re just beginning to invest,â€ says Chuck Daggs, the national sales manager for the bankâ€™s Private Client Services division, which includes its bank-based brokers as well as its full-service brokers, along with several other lines of business such as its private banking and trust business.
â€œWe have bankers in our bank branches who have been traditional bankers, and weâ€™re now getting them licensed so that they can provide investment advice and direction for clients in that mass market segment,â€ Daggs says.
About two-thirds of Wellsâ€™ full-service brokers are also situated in the bankâ€™s branches, so when a Series 7 licensed banker finds a client who has more than $100,000 to invest, the banker will refer the client to one of the full-service brokers whoâ€™s there in the branch as well, he says.
â€œI think the individual investor public is becoming more sophisticated and their expectations are much higher. They really do expect people to sit down and spend time with them, and understand what their objectives are, and what kind of risks theyâ€™re willing to take. Then, based on that, come up with a very specific asset allocation, and implement that asset allocation using mutual funds or separate account managers,â€ explains Daggs.
The managed accounts area is a complex one. Thereâ€™s a lot that goes into building all of the software and technology, and also in training people who are more accustomed to a bank environment to take on more of an advisory role. By now, there are many variations of the accounts, and each bank has to figure out where it wants to be on the spectrum. Davis of MMI says that when he speaks at conferences, he often has conversations with bankers who are just starting to work their way through the terminology â€“ SMA, UMA, UDA. However, Davis admits that they say: â€œI donâ€™t have a choice; I have to figure it out.â€
Finally, Davis concludes that, in his opinion, any bank that â€œdoesnâ€™t have managed accounts as a key component to address [as part of its plan for the next five years] might just as well go out there and get run over in traffic.â€