Press Room
So much for traditional outsourcing
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Points of contention
“Partly because of their creation by wirehouse brokerage firms with a traditional mass-affluent clientele, and partly because of the antiquated technology that underlies the majority of the platforms that exist today, the cost to a wealth-management firm for [an] open architecture [program] is [between 85 and 100 basis points] for equity management,” Smurl writes in an letter to CFA Magazine that he shared with Family Wealth Report. “For most firms looking to make a change from a purely proprietary approach, this is a non-starter.”
Compass wanted control of the investment process in order to provide its clients customized asset allocations across investment managers and products—including, where appropriate, in-house styles—in addition to aligning trades, managing cash flow and enhancing the overall tax efficiency of their portfolios.
In other words, it didn’t want an outside overlay manager in the mix. “First-generation UMAs, for all their benefits, are still cookie-cutter asset-allocation models that deny wealth-management firms the control they need to provide full value to their clients and usually outsource money-manager due diligence,” Smurl writes in his letter to CFA Magazine. Custody was another sore spot for Compass in its search for an outsourced SMA solution. Many wealth management outfits are custody-neutral, either out of preference or to suit their clients. But “most separate account programs, UMAs included, want to control the custody of assets and tend to charge a premium for custody, clearing and execution,” he says. “This is consistent with the brokerage channel’s desire to wrap the trading costs into a single fee to the client, [an imperative born of a time, prior to 1 May 1975, when brokerages charged standardized rather than negotiated commissions for trades that is no longer] relevant in the low-trading-commission environment of today.”
But most critically, Compass felt that SMA platform providers don’t give wealth managers enough leeway to provide adequate customization. “Clients rarely arrive at the front door with 100% cash, begging us to immediately invest them into the efficient frontier,” says Smurl. Rather, they’re apt to have multiple account registrations, pre-existing holdings—some with low tax bases—and personal preferences they want expressed in their portfolios.
Sorting through such complexities calls for a “local, hands-on investment professional” who works with the client to make “security-specific decisions,” Smurl writes. Customization on that level calls for “minimizing net recognized gains, allowing short-term gains to mature to long-term status, swapping tax lots among managers, and actively harvesting losses throughout the year”—things that Smurl says “first-generation” UMAs simply can’t handle to the degree required by Compass’ clients. In fact, says Smurl, inadequate customization is the main reason “that there is such a low adoption rate among wealth-management firms of non-proprietary investment programs.”
Brave new world
Compass came across Smartleaf early in its hunt for a suitable approach to SMAs. Smurl says the software maker’s portfolio-management was impressive enough, but the bank was reluctant at first to go whole-hog with a small and little-tested company. Smartleaf’s White says his firm now has 15 clients, thanks in part to a year-old partnership with SunGard. But in 2004, when Compass was giving Smartleaf the once-over, it had only three.
Still, a few months after signing on with an SMA platform provider that Smurl prefers not to name, Compass decided to use Smartleaf’s overlay-management software for its all-proprietary equity products.
White says Compass could do that because reconciling trades of assets managed in house doesn’t require connectivity with outsiders. But then neither does reconciliation for multi-manager offerings in UMAs, since outside managers participate solely as providers of intellectual capital, not as account administrators.
Compass saw that too, says Smurl, and—impressed with Smartleaf’s on-time delivery and “exceptional” training and support—decided to use Smartleaf’s software to manage its entire equity platform. That, combined with Denver-based Prima Capital’s manager research and due diligence, has given Compass the advisor-driven overlay management it wanted at heart of its UMA program. “Doing the overlay in house is part of our value proposition to the client,” says Smurl.
Smartleaf’s software subjects portfolios to a daily round of rules-based and mathematically optimized tests. The result is a set of security-specific recommendations that goes into a web-based report, giving the advisor a steady flow of up-to-date account data for checking model drift, reconciling redundant holdings, or improving the overall tax efficiency of the portfolio.
“Smartleaf improves our operating efficiency,” says Smurl. “It’s really a workflow tool.” Smurl also likens it to MapQuest, an online location-search provider. “You already know where you want to go; Smartleaf tells you how to get there.”
For all of that, Smartleaf has a reputation for complexity—for which White makes no apologies. “It is sophisticated,” he says. “It’s for portfolio managers, not brokers.”
Meanwhile, investors are responding positively to Compass’ “SmartPath Portfolio” platform, according to the bank. “Everybody loves it,” says Smurl.
Compass’ “a la carte” approach to building an SMA platform makes sense for banks with “in-house investment expertise,” says Scott MacKillop, head of investment services at U.S. Fiduciary, a Sugar Land, Texas-based wealth management firm and third-party investment provider. “They don’t necessarily need the client profiling and performance reporting offered by some of the [third-party providers].”
But Smurl says Compass’ approach to SMAs isn’t just a matter of a bank using a little ingenuity to get what it wants from the marketplace. In his view it’s “a paradigm shift” that could usher in broader adoption of hybrid architecture by wealth managers. “Cost, control, custody and customization are no longer [obstacles] for wealth-management firms looking to implement separate-account platforms for their clients”—and that, he says in his letter, opens up “new frontiers in investment management.”
Compass has more than 380 branches in Alabama, Arizona, Colorado, Florida, New Mexico and Texas. Its Houston-based wealth unit manages assets of about $4 billion. –FWR