SMAs Still Lack Automation

As the popularity of separately managed accounts grows, so do the processing and operational headaches for money managers.

Assets in separately managed accounts (SMAs) reached $620 billion in June, an increase of 17 percent over the previous year and a 40 percent jump from the first half of 2003, according to the Washington, D.C.-based Money Management Institute (MMI). Yet for all the gains in SMAs, operational challenges continue to beleaguer the industry, hindering the potential for greater growth.

The standard investment management operations model does not apply to separately managed accounts, explains Vincent Lepore, senior adviser to the MMI's board of governors for technology and operations. Typically, as investment management operations grow, they achieve "volume-driven cost reductions because your basic cost is covered and you just leverage off the original cost," he says. "Not so in the SMA industry," where growing volume translates to increased operational complexity - and, often, higher costs.

The primary difficulty exists in the multitude of relationships among the sponsors that maintain the relationships with the clients and the asset managers that manage the money. A money manager may have relationships with 30 plan sponsors, and each sponsor may require different documentation and rely on different forms of communication, including e-mail, fax, telephone and proprietary data downloads.

The problem is most acute for money managers administering new accounts, for which each sponsor has different forms and different criteria for approvals, says Matt Schott, senior analyst with Needham, Mass.-based TowerGroup. Consequently, the money managers face a deluge of paper that may or may not have all the necessary data to determine whether the account meets compliance considerations, he relates.

Trading presents another pain point for money managers. "If the money manager decides it's going to change its model, it has to log on to 30 different [sponsor] systems," says Schott. "It is a very manual process [that is] very prone to error."

Adding to the complexity of the SMA industry's operations are new performance reporting standards for SMAs that will be introduced on Jan. 1, 2006, by the Charlottesville, Va.-based CFA Institute, the investment professionals' standards organization formerly known as the Association for Investment Management and Research (AIMR). The standards currently include a carve-out provision by which a money manager could be CFA-compliant on its institutional business but not on its managed account business, according to Schott.

Though this provision is being debated, if it is stricken from the standards, sponsors - who maintain the account books and records - will "need to make the books readily accessible in data files" to assist money managers in achieving compliance, Schott points out. The added requirements and subsequent data exchange obviously would increase operational complexity.

Trying to Ease the Pain

In response to these challenges, the MMI has developed communications standards in order to simplify operations in areas considered high pain points, including the opening of new accounts, adding and reducing funds, tax trading guidance, changing restrictions, and changing investment styles, relates the organization's Lepore. A version of the standards is published on the MMI Web site (www.moneyinstitute.com), and a second edition is due this fall.

Originally, the plan was for the National Securities Clearing Corp. (NSCC; New York) to wrap technical and communications protocols around the MMI's standards, according to TowerGroup's Schott. Following the Fund/SERV model, the envisaged service - announced in October 2003 - would have operated as a hub among the broker-dealer sponsors and investment managers to centralize communications and eliminate the multiple connections currently required. However, the proposal was subsequently withdrawn.

The reason for that, according to Schott, was the Depository Trust & Clearing Corporation's (DTCC; New York) concern about whether the plan had sufficient backing in the industry. While supportive of the idea of standards, some market participants believed the protocols should be a truly open specification, explains Schott. Rather than being obligated to leverage the NSCC, they wanted to ensure that other firms could take the standards and offer capabilities around them in a more competitive environment, he continues.

Standardization, therefore, remains some way off, even though, as Marc Zeitoun, senior vice president with New York-based UBS Financial Services, says, "Everyone recognizes moving to a common platform - or a common language in a common clearing system - will bring huge efficiency." But Zeitoun acknowledges the challenges to establishing standards. "We all want to grow our market share - we don't want to stop to rebuild," he says. "The standardization project will represent a very costly endeavor for the entire industry, simply because you have to change everything built over the last 20 years."

Even so, Zeitoun believes there are two steps to achieving a unified standard. "The first is simply agreeing on a language," he says. "The second phase can be whose utility you use."

For now, the MMI continues to wrestle with standards. To this end, it has issued a request for proposal to a number of consultants in order to help the institute determine the best course of action, says MMI's Lepore. Still, he notes, "There will be some time before this thing moves forward in anything other than a very incremental way."

In the meantime, despite the lack of a total end-to-end automation solution, market participants do have some options. For example, Birmingham, Ala.-based Compass Bank has implemented Cambridge, Mass.-based Smartleaf's Portfolio Manager. The bank went live with the system in May, and it now supports almost $1 billion in assets under management.

Compass has contracts with a number of external money managers, which provide models for their particular style of trading, according to Irene Ku, the bank's head of wealth management operations. "We load the managers' models into Smartleaf, then set up profiles for each of our clients," she explains. "Smartleaf does the analysis, and then the recommended trades come back and we execute them."

Ku concedes that communicating with Compass' money managers is not the most efficient process - spreadsheets are shared via e-mail, and the data is loaded manually into Smartleaf. But the main challenge for Compass was establishing the interface between Smartleaf and its accounting and trading system, she notes. "That interface is critical because data has to come back from Smartleaf into our accounting and trading system [SEI Investment's Trust 3000 system] so that we can then execute the trades, maintain the records and generate statements for each client."

The Shadow Knows

To automate part of their portfolio management operations, some money managers are opting to "shadow post," a process in which they get data files from their sponsors, run them through a portfolio accounting system and then reconcile them back to the sponsor system, TowerGroup's Schott relates. To accomplish this, managers can choose to build the portfolio accounting functionality in-house, license vendor software or use a vendor's technology on an application service provider (ASP) basis. Schott points to three main providers in the vendor space - Vestmark, CheckFree and Market Street Advisors.

Wakefield, Mass.-based Vestmark has partnered with Thomson Financial (New York) to use Thomson's Portia product in the Vestmark Managed Account Platform (VMAP). Portia provides multicurrency portfolio accounting, trade order management and performance reporting. Vestmark also has built technology around Portia in order to abstract the interconnectivity issues and create more of a standard workflow for money managers, according to Schott. Vestmark offers VMAP on an ASP basis or as licensed software.

Likewise, Atlanta-based CheckFree is enhancing the workflow capabilities of its APL portfolio management system in the areas of new accounts and reconciliation with the introduction of New Account Workflow, a rules-based process based on MMI data standards. CheckFree also is developing Enhanced Portfolio Lifecycle (EPL), a new system based on Microsoft .NET architecture that will offer multicurrency accounting, real-time transaction processing and enhanced fixed-income capabilities.

For its offering, Market Street Advisors (Edison, N.J.) also relies on a third-party portfolio system, Eagle Investment Systems' Star multicurrency portfolio accounting engine, with Web interface and workflow capabilities, says Schott. The Web-based MSA platform is offered on an ASP basis.

Outsourcing Gains Traction

Another alternative for money managers is to outsource portfolio management to a custodian banks or third-party fund outsourcers that has developed SMA services. Cincinnati-based Fifth Third Asset Management (FTAM), for example, previously distributed SMAs through its own broker-dealer and high-net-worth channels, supporting the operations internally. However, at the beginning of the year, it opted to go to outside broker-dealers in an effort to grow its business. "We had about $200 million of separately managed accounts in-house, but we have a pretty big strategic push to garner billions of assets over the next three to five years outside our own channel," relates Christopher Bell, FTAM's COO.

Speed to market and reliable processing capabilities were key considerations in the decision to outsource to New York-based BISYS, relates Bell. "We had the chance to jump on one of the biggest platforms in the country ... and that necessitated us getting up to speed very quickly," he says. "So I didn't really want to develop the facility in-house."

While FTAM already has a relationship with BISYS on the mutual fund side of its business, the biggest reason FTAM chose to outsource its SMA program to BISYS was the vendor's technology, which stems from BISYS' strategic alliance with Vestmark, according to Bell. Under the alliance, BISYS has integrated its proprietary reconciliation, pricing and corporate actions technology with components of the Vestmark platform, including Thomson's Portia engine and Vestmark's workflow tools. "We really liked the new functionality Vestmark has put together with BISYS," Bell says.

The BISYS platform is Web-based and includes an accounting engine, a front-office tool and workflow tools, relates Christian Bolanos, VP of business development with BISYS Investment Services. "So an asset manager can have one platform to work on all their accounts and rebalance their trades, and let BISYS handle the interactions and connections out to their sponsor community," he says.

Citigroup is a more recent entrant into the SMA market, having launched its SMA outsourcing platform in March. Its suite of services occupies four broad categories, explains Andrew Clipper, director and product manager for asset manager solutions with New York-based Citigroup Global Transaction Services (GTS). In the area of portfolio management, Citigroup GTS provides automated workflow management and enables investment managers to manage portfolios and restrictions on an automated and unlimited basis, with a system that scales to the hundreds of thousands of accounts needed within the SMA industry, according to Clipper.

On the trading side, Clipper notes, Citigroup has taken the hodge-podge of faxes, phone calls, e-mails, electronic links and the odd FIX connection and pulled it together on a single trading platform. The final piece of the platform, he adds, is the account opening and maintenance process.

"Previously, it was a cobbling together of faxes, e-mails and hard-copy contracts," says Clipper. "We take all those different formats and integrate them." According to Clipper, Citigroup estimates that it can offer a 30 percent cost saving compared to clients servicing their own accounts.

With such promises of double-digit cost savings, outsourcing is gaining some traction. Yet, there still is the potential for friction between the client and provider. "The outsourcers want to handle more volumes, and, to the greatest extent possible, handle those in a standard way; whereas the client wants some customized ability and flexibility," notes TowerGroup's Schott.

In spite of the progress made to date, the SMA world still remains far from fully automated. And as the SMA space evolves, the operational demands are only going to get more complex.