Tiburon Strategic Advisors, LLC



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Financial Institutions Topics Series

Separately Managed Account (SMA) Programs:

Accelerating Shift to Direct Indexing

(Key Findings)

October 5, 2021

KEY FINDINGS

Separately Managed Account (SMA) Programs Market Evolution

Separately managed account (SMA) programs market evolution includes it context setting, market history, market growth, & leaders.

Context Setting

Economic Value Chain

• The economic value chain of a separately managed account (SMA) programs can be a helpful point of context, with the largest share of the fee going to the financial advisor and his or her firm

• Nearly half of separately managed account (SMA) program assets under management are held in individual retirement accounts (IRAs)

• Over half of separately managed accounts’ (SMAs’) programs net flows are new cash from individual retirement account (IRA) rollovers & other

• Industry experts attribute much of separately managed accounts’ (SMAs’) programs growth to individual retirement accounts (IRAs) rollovers, contributing to 25% of net flows

• Nearly all separately managed account (SMA) program investors are pleased with their investments

Benefits

• There are four perceived benefits to separately managed accounts (SMAs) over mutual funds, including manager access, increased visibility, tax benefits, & customization

• Separately managed account (SMA) program sponsors are eager to tout the perceived benefits of separately managed accounts (SMAs); however, many are realistic with their comments

• Overall, while separately managed account (SMA) investors value manager access and visibility, financial advisors focus on tax advantages & customization

• The first core perceived benefit of separately managed accounts (SMAs) is access to superior money managers

• The biggest draw of high net worth investors to separately managed account (SMA) programs is the access to otherwise unavailable money managers

• Three-quarters of separately managed account (SMA) investors said that access to good portfolio managers was a very important overall feature

• Very few financial advisors feel that manager access is extremely important in their separately managed account (SMA) recommendation process

• The second perceived benefit of separately managed accounts (SMAs) is increased visibility

• The increased visibility of separately managed accounts (SMAs) includes that of holdings, fees, & communications

• Nearly two-thirds of separately managed account (SMA) investors consider visibility as a very important separately managed accounts advantage

• However, less than one-fifth of all high net worth investors are drawn to separately managed account (SMA) programs for their asset-based fee structure

• Less than one-fifth of high net worth investors are drawn to separately managed account (SMA) programs for their all-inclusive fee structure

• Less than half of financial advisors consider visibility of fees to be a very important separately managed account (SMA) program advantage

• The third perceived benefit of separately managed account (SMA) programs is tax benefits

• Less than half of all high net worth investors are drawn to separately managed account (SMA) programs for their tax efficiency

• Over half of separately managed account program (SMA) investors say tax management features are a very important advantage

• Almost two-thirds of clients are paying more attention to tax efficiency than they did a year ago

• Some believe that separately managed accounts (SMAs) are more tax efficient and that tax management can yield 50-100 basis points more per year

• Some financial advisors use separately managed account (SMA) holdings to offset tax liabilities in other areas of clients’ portfolio such as a real estate transaction

• Investors pay ordinary tax rates on dividends & interest and lower capital gains tax rates when they sell

• There are four factors that can affect after-tax returns, including turnover, cash flows, and external gains

• Over three-quarters of clients are utilizing tax loss harvesting

• Interestingly, some argue that mutual funds are more tax aware

• Only half of separate account managers (sams) have addressed the issue of taxes

• The mutual fund industry has taken steps to address the issue of taxes

• Separate account managers (SAMs) still need to take action to address tax issues

• Separately managed accounts (SMAs) may benefit from recent changes in tax laws

• Many separately managed accounts (SMAs) assets under management are in individual retirement accounts (IRAs) which are not taxable

• Consumers see the importance of tax efficiency, rating its importance as a 7.4 out of 10

• Program sponsors & money managers believe that tax efficiency is increasingly becoming a key factor in separately managed accounts (SMAs)

• Full-service brokers rate the importance of tax efficiency in selling separately managed accounts (SMAs) as an 8.2 out of 10

• Many full-service brokers believe tax efficiency is a crucial advantage of separately managed accounts (SMAs), whereas others do not

• The fourth perceived benefit of separately managed accounts (SMAs) is the ability to customize accounts

• Customization is possible in separately managed accounts (SMAs) in the realms of avoiding certain individual stocks and building around existing portfolios

• One common sales analogy for the decision between mutual funds and separately managed accounts (SMAs) is building a house

• The amount of allowable customization in practice varies by manager due to technology & philosophy constraints

• Program sponsors & money managers feel that customization is a key feature

• While overall customization of separately managed accounts (SMAs) amongst full-service brokers is low, there are mixed reponses on the individual level

• Full-service brokers rate the importance of customization in selling separately managed accounts (SMAs) as a 6.8 out of 10

• Full-service brokers have differing opinions about the importance of customization to clients, with some saying clients like to know the option to customize is there but do not use it

• Cpas tend to love the customization features of separately managed accounts (SMAs) because they can add value

• Overall, the relative characteristics of separately managed accounts (SMAs) and mutual funds can be debated

Concerns

• Concerns regarding traditional separately managed accounts (SMAs) include account minimums, due diligence, lack of asset allocation, & less regulation

• Most minimums are still $100,000-to-$250,000

• Being un-invested when accounts transfer is an issue with separate accounts

• Portfolio managers are likely to focus on mutual funds which they manage because those are reported in the newspaper every day

• Multiple separately managed accounts (SMAs) can lead to possible security overlaps and wash sales

• Some separately managed accounts (SMAs) may receive non-timely execution due to their broker-centric structure

• Dispersion in separately managed accounts (SMAs) account performance can be huge

• Paperwork for separately managed accounts (SMAs) can be a nightmare

Market History

Separately managed account (SMA) programs were founded in 1976 and have subsequently evolved through their unique offer, mutual fund wrap account challenges, & unified managed account (UMA) replacement phases.

• EF Hutton created the first separately managed accounts (SMAs) program in 1976

Unique Offer Phase

• Mitsubishi UFJ Financial Group’s Morgan Stanley’s Eaton Vance’s Parametric was founded by Bill Cornelius, Mark England-Markun, & Randy Lert in 1987

• Franklin Resources’ O’Shaughnessy Asset Management was founded in 1996

• BlackRock’s Aperio Group was founded by Patrick Geddes & Paul Solli in 1999

Mutual Fund Wrap Account Challenges Phase

• Mitsubishi UFJ Financial Group’s Morgan Stanley’s Eaton Vance acquired an 80% stake in Parametric in 2003

• The Money Management Institute wanted to create operating standards for separately managed account operations in 2006

Unified Managed Account (UMA) Replacement Phase

• JP Morgan Chase & Company’s OpenInvest was founded in 2015

• The Vanguard Group’s Just Invest was founded in 2016

• Franklin Resources’ O’Shaughnessy Asset Management launched its Canvas custom indexing solution in 2019

Direct Indexing Emergence Phase

• Mitsubishi UFJ Financial Group’s Morgan Stanley acquired Eaton Vance in 2020

• BlackRock acquired Aperio Group in 2020

• The Charles Schwab Corporation acquired Motif Investing’s technology in 2020

• Franklin Resources acquired O’Shaughnessy Asset Management in 2021

• The Vanguard Group acquired Just Invest in 2021

• JP Morgan Chase & Company acquired OpenInvest in 2021

• Dimensional Fund Advisors lowered its separately managed account minimum account size to $500,000 in 2021

Market Growth

Separately managed accounts (SMAs) programs market growth can specifically be measured by the number of sponsors, and their number of programs, financial advisors, clients, accounts, net new accounts, assets under management, net flows, & revenues.

• There are 100 separately managed account (SMA) programs sponsors

• Separately managed account (SMA) programs sponsors offer 200 programs, up from nineteen in 1995

• Separately managed account (SMA) programs serve 20,000 financial advisors

• Separately managed account (SMA) programs serve 1.0 million clients

• Separately managed account (SMA) programs have gathered 1.0 million accounts, down from 1.6 million in 2001 & its peak of 2.5 million in 2006

• Separately managed account (SMA) programs gather 100,000 net new accounts, down from 500,000 in 2002

• The average separately managed account (SMA) programs is $322,422, up from $206,600 in 2002

• One study showed that program sponsors have an average account size of about $275,000

• Banks have the highest average account size amongst leading separately managed account (SMA) programs markets

• Separately managed account (SMA) programs have gathered $1.3 trillion assets under management, up from $79 billion in 1992

• Wirehouses now control only half of separately managed account (SMA) programs assets under management

• Separately managed account (SMA) programs gather $93 billion net flows, up from $18 billion in 2001 but down from its peak of $81 billion in 2005

• Separately managed account (SMA) programs generate $4.8 billion revenues, up from $4.0 billion in 2017

• Separately managed account (SMA) programs earn $2.4 billion, up from $2.0 billion in 2017

Leading Separately Managed Account (SMA) Programs Sponsors

The leading separately managed accounts (SMAs) programs sponsors can specifically be ranked by their number of programs, financial advisors, clients, accounts, net new accounts, assets under management, net flows, & revenues.

• Morgan Stanley is the leading separately managed account (SMA) program sponsor in terms of assets under management, with $313 billion

Market Segments

Market Definition

Separately managed account (SMA) programs can be defined to include single contract & dual contract programs.

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Separately managed account (SMA) programs can be segmented to include single contract & dual contract programs

• Nearly two-thirds of assets under management today are in bundled programs, with the other one-third from old unbundled programs

• While the standard view of a separately managed account program involve non-proprietary managers one also needs to take into account the proprietary separately managed account (SMA) programs which account for almost one-quarter of all assets under management

Single Contract Programs

Separately managed accounts (SMAs) programs’ first market segment is single contract programs.

Market Growth

Separately managed accounts (SMAs) single contract programs market growth can specifically be measured by the number of sponsors, and their number of programs, financial advisor clients, clients, accounts, net new accounts, assets under management, net flows, & revenues.

• Separately managed accounts (SMAs) single contract programs have gathered $497 billion assets under management, up from $470 billion in 2003

Leading Separately Managed Accounts (SMAs) Single Contract Programs Sponsors

The leading separately managed accounts (SMAs) single contract programs sponsors can specifically be ranked by their number of programs, financial advisors, clients, accounts, net new accounts, assets under management, net flows, & revenues.

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Dual Contract Programs

Separately managed accounts (SMAs) programs’ second market segment is dual contract programs.

Market Growth

Separately managed accounts (SMAs) dual contract programs market growth can specifically be measured by the number of sponsors, and their number of programs, financial advisor clients, clients, accounts, net new accounts, assets under management, net flows, & revenues.

• Separately managed accounts (SMAs) dual contract programs have gathered $406 billion assets under management, up from $129 billion in 2008

Leading Separately Managed Accounts (SMAs) Dual Contract Programs Sponsors

The leading separately managed accounts (SMAs) dual contract programs sponsors can specifically be ranked by their number of programs, financial advisors, clients, accounts, net new accounts, assets under management, net flows, & revenues.

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Future Predictions

Separately managed account (SMA) programs’ future predictions include renewed growth due to direct indexing & moderate growth for separately managed account (SMA) programs.

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Renewed Growth Due to Direct Indexing

• Personalized indexing (direct indexing) has gathered $363 billion assets under management, up from $50 billion in 2009

• Parametric Advisors is the leader in personalized indexing (direct indexing) assets under management at $120.0 billion

Moderate Growth for Separately Managed Account (SMA) Programs

• Program sponsors & money managers rate the future of separately managed accounts (SMAs) as only moderate, with an average score of 6.2

• Full-service brokers seem to be extremely excited about separately managed accounts (SMAs), rating their future as a 9.6

• Separately managed account (SMA) programs will have 130 sponsors by 2023, up from 100 in 2017

• Separately managed account (SMA) program sponsors will offer 270 programs by 2024, up from 200 in 2017

• Separately managed account (SMA) programs will serve 26,000 financial advisors by 2023, up from 20,000 in 2017

• Separately managed account (SMA) programs will serve 1.6 million clients by 2023, up from 1.0 million in 2017

• Separately managed account (SMA) programs will have gathered 1.6 million accounts by 2023, up from 1.0 million in 2017

• Separately managed account (SMA) programs will gather 160,000 net new accounts by 2023, up from 100,000 in 2017

• Separately managed account (SMA) programs will have an average account size of $350,000 in 2023, consistent since 2017

• Separately managed account (SMA) programs will have gathered $1.6 trillion assets under management by 2025, up from $1.3 trillion in 2020

• Separately managed accounts will gather $80 billion net flows by 2025, up from $63 billion in 2020

• Separately managed account (SMA) programs will generate $4.6 billion revenues by 2023, up from $3.9 billion in 2016

• Separately managed account (SMA) programs will earn $2.6 billion by 2023, up from $1.9 billion in 2016

Fastest Growth in Model-Based Trading Method

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Renewed Growth in Dual Contract Programs Due to Portability

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Declining Fees for Separately Managed Account (SMA) Programs

• The average separately managed account (SMA) client pays 1.75%, down from 2.11% in 1998

• Full-service brokers rate the importance of pricing in actually selling separately managed accounts (SMAs) as only a 6.2

Declining Fees for Manager Participants

• Only half of financial advisors consider historical manager performance to be extremely important in the recommendation process

• Full-service brokers rate the importance of superior manager menus in selling separately managed accounts (SMAs) as a 9.6

• Almost half of full-service brokers use one separate account manager per client, and another one-third use just two or three, hence clients get limited diversification

• Over two-thirds of the managers across programs are consistent at the end of the day

• One-third of money managers are terminated from their position with companies

• Almost three-quarters of programs increased manager rosters

• Large cap equity managers dominate all programs, capturing half of all assets under management

• Additionally, large cap equity continues to gather over half of separately managed account (SMA) net flows

• Favorite separate account managers tend to get 5%-to-25% of assets in separately managed account (SMA) programs

• Manager fees across all program sponsors and in all investment styles have decreased in recent years

• Wirehouses have been the most successful at driving down manager fees

• Wirehouses pay 38 basis points for equity managers while many TAMPs pay 50 basis points

• The average number of sponsor relationships ranges from fourteen-to-34 depending on manager size

• The largest managers have increased their number of program sponsor relationships in recent years from 31-to-34

• Mid-tier managers have doubled their number of sponsor relationships in recent years from seven-to-fourteen

• Almost three-quarters of managers plan to increase their number of sponsor relationships

• Almost 400 separate account managers compete in the separately managed accounts market, up over 100% since 2001

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