UMAs in the broker/dealer - What will it take?

A number of broker/dealers are looking to offer separately managed accounts, unified managed accounts or some sort of overlay capabilities to their reps. Indeed, we've heard more than one chief executive recently refer to them as the wave of the future. But integrating the technology in a cost-effective manner is an ongoing challenge, one with which firms continue to struggle. We turned to SMA pioneer Len Reinhart for help. The president of Lockwood Advisors, an affiliate of clearing giant Pershing, took time to explain where broker/dealers are in the UMA integration process, and what the near future holds for the concept.

Boomer Market Advisor: Why do UMAs fit so well with the broker/dealer and independent advisor business models?

Len Reinhart: Baby boomers are taking more of a retirement management mentality, rather than a wealth accumulation mentality. That's what's driving this. You're seeing much more of a solutions based sale to this emerging market rather than "find me the best mutual fund, or the best stock." Historically, if you look at how financial products have been sold, it's been silo by silo. People would go and select different products and they would think they're getting the best out of each silo, but when they put it all together, it was sort of a hodgepodge of investments. Part of what's now coming about is due to the mentality of advisors and clients as they get older. They say, "Hey, I want a plan. I don't want to do this silo by silo anymore. I want you to come in, look at my circumstances and give me a mix of products that are going to meet my needs." If you talk to an independent, fee-only advisor, it's something they've been saying they've been doing for years, but when you look at the broker/dealer, they haven't had the technology platforms in place to do it.

BMA: So where do UMAs fit in?

LR: I look at the UMA not as product, but really as a platform to deliver this managed solution. It helps brokers and advisors figure out how to go to the client with one solution set, one that has with multiple products in one account. This is a big transition in the way brokers and advisors have delivered solutions to the clients. I think it's probably the biggest change in about 30 years.

BMA: We assume that reps that are thinking of offering UMAs would have to be pretty far along in the fee-based movement.

LR: Fee-based certainly helps. If the rep is going to recommend a portfolio product for the client, he has to do it in an un-conflicted fashion. I can't get paid more to recommend a hedge fund to you than if I recommend an ETF. You have to fee-neutralize all these products. That's one of the things making it fairly complicated. That's an area a lot of firms are struggling with.

BMA: Do you have a sense of where we are in the process of getting UMAs into broker/dealers?

LR: I think it's at the beginning stages, certainly. If you look at Cerulli Associates' numbers, you'll see something like $26 billion in UMAs, which isn't a lot. I think it's actually less than that and here's why. Multiple discipline accounts were an interim step. MDAs took two or three SMAs and put them into one account. This is where the term overlay management came from. Once you put two or three separate account managers into one account, you needed an overlay manager to manage each of the bigger portfolios. Those programs came about five or six years ago. Some of them did very well. A few of the wirehouses had some big programs. Since then, they've added ETFs to the mix and now they're calling it a UMA. So, MDAs quickly became UMAs by simply adding a few ETFs. But if you take those wirehouses out, I think you're really more down in the $5 billion to $8 billion balance.

BMA: So independent broker/dealers are looking to offer the true UMA design, as opposed to what the wirehouses offer

LR: True UMA offerings, in my mind, mean they have at least three or four different asset classes and at least three or four products in the mix. I think [adoption rates] for those are still fairly small.

BMA: Eventually, will everyone be able to offer UMA services or is there a minimum account size that has to occur to make it worthwhile? In other words, will a small boutique shop be able to tap into the economies-of-scale in order to offer UMAs, or is it only going to be the larger independent firms?

LR: Well, yes, the smaller firms will be able to offer them because they're going to be able to access other people's platforms. If you look at what we're doing at Lockwood and Pershing, we have a UMA that we manage that just crossed $1 billion dollars. It's a cool product. But we've learned from it, and now we're building Pershing Managed Account Solutions, which is the platform to deliver UMAs, but allows any broker/dealer to put in whatever rules engine they want. So, if they want to pick mutual funds, ETFs and SMAs, they can do it; we'll give them the technology and operational support. I think that right now if a rep said, "Okay, I have to go to a firm that has a UMA," there are not a lot of alternatives. I think that a year from now, or two or three, it's going to become a standard. Firms will have to have this or it's going to be tough to compete.

BMA: Some SMA providers have attempted to come significantly down-market with very low minimum investments. I don't think they ever made the math work. What I hear from you is that it won't be a consideration in the UMA space, because the smaller firms can always outsource part of their capabilities to other companies.

LR: There are two things. The biggest hurdle to a small broker/dealer is if they have to build this entire technology platform themselves. We spent in excess of $10 million so far. For them it'd be a big knot. They can buy the platform from somebody like us. We have a UMA that includes separate accounts and alternative investments, market neutral hedge funds, things like that. The minimum for that is $250,000. But now we also have a UMA at $25,000, called Lockwood Asset Allocation Portfolios, but there you can't get SMAs or alternatives. You're basically going to get mutual funds and ETFs. So, anybody can get a UMA, but based on the size of the assets, it will restrict which investment vehicles can be included.

BMA: Estimates of where industry-wide SMA assets would be at this point haven't worked out as originally thought. Is UMA innovation making up for the shortfall?

LR: Yeah, absolutely. UMAs are taking off. What we call the advisor-directed UMA platform, which for the rules engine I talked about, is going to explode in growth. I don't think SMAs are going away. But the smaller account marketplace, maybe under $500,000, will evolve to the UMA. Those people will want UMAs so they can get better diversification for their $200,000. As that number goes up, I think clients will want to deal directly with individual managers, rather than with an overlay manager. So over time, it will be exactly the opposite of the trend that we have seen up until now, one in which people try to bring the minimum account size down on SMAs. I think you're going to see it go up. You're then going to see UMAs come in underneath and take the majority of the smaller business.

BMA: So solid growth prospects for the managed account space?

LR: It's a burgeoning business. It's new. I don't see anything that can stop it. It's sort of like the perfect storm. Everything's building to it and it's the right thing for the client.