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Sizing Up Tailored Portfolios


Separately managed accounts hit the scene in the 1990s, a Wall Street invention to give individual investors what mutual funds couldn't: a personalized portfolio, the ability to see every trade, and an opportunity to take gains or losses in ways that can minimize taxes. Investors didn't need a seven-figure account to sign up. A $100,000 minimum investment was enough. All that extra service came at a price -- as high as 3% of assets per year.

Today, some 2.1 million so-called SMAs command about $613 billion in assets. Mutual funds and hedge funds receive far more attention, much of it unflattering. Still, if you ask the investors who have SMAs how well they like them, you'll find that they're a content bunch.

A soon-to-be-released study commissioned by Citigroup Asset Management () found that 90% of the 251 SMA investors polled are happy with their accounts. That's an "off-the-charts" satisfaction rate when compared with other financial products, says Brian Perlman, vice-president at Mathew Greenwald & Associates, which conducted the research for Citigroup. Through its Smith Barney unit, Citi is one of the largest purveyors of SMAs.

Yet there is some evidence that SMA investors don't grasp the product's features very well. For instance, what they say they like most about SMAs is something they don't really have: direct access to the people managing their money. "You're not going to have dinner or coffee in Starbucks () with portfolio managers," says Peter Cieszko, head of the U.S. retail and high net worth group at Citigroup Asset Management.

In reality, contact with a manager is more remote. Most of the time, the financial adviser at Smith Barney or Merrill Lynch () provides information and fields questions about that account. Investors can arrange to get e-mails when a stock is bought or sold as well as invitations to listen in on Webcasts and conference calls with portfolio managers. Citigroup also offers hot lines with recorded updates from managers. Last year the service logged more than 40,000 calls, Cieszko says.

The Citi study also found that SMA investors don't make use of some of the features that distinguish these accounts from mutual funds. Here are some of the key findings:

TAXES

Some 58% of investors polled say they have never instructed their financial adviser to take a gain or loss in their SMAs for tax purposes. That leaves the timing of gains and losses to the portfolio manager who doesn't know investors' particular circumstances -- essentially the same as with mutual funds. In promoting SMAs, Wall Street has often highlighted the ability to maximize tax benefits as an important selling point.

Why aren't investors using this feature more? In recent years, investors haven't had a lot of gains they needed to shelter, says T.J. Goelz, a financial adviser at Smith Barney in Sarasota, Fla. The Citi study also quizzed 400 financial advisers, and they say that the majority of SMAs they oversee are in tax-deferred retirement accounts, which may explain why their clients aren't worrying about tax issues.

CUSTOMIZATION

Only 52% polled say they have asked their portfolio managers to exclude or include certain stocks. Melissa Gohs, a Morgan Stanley () financial adviser in Danville, Calif., has a client who needed some special attention. With more than 100,000 shares of Liberty Media () outside his SMA, "He certainly doesn't need any more media stocks," Gohs says. To make sure the client's total portfolio remains diversified, Gohs asked the manager not to invest in any media stocks.

COSTS

In the early days the annual fee on equity-based SMAs was a stiff 3% of assets. That made it near impossible for an account to beat the Standard & Poor's 500-stock index on a sustained basis. But thanks to competition and higher balances, most investors are now paying less than the rack rate -- about 2.25%. That's still more than mutual funds, but the gap is narrowing. About two-thirds of SMA investors say they pay fees and expenses that are about the same or less than mutual funds.

PERFORMANCE

Two-thirds of those polled say SMAs outperform mutual funds and stocks. But tracking that performance can be tough. Because the portfolios are tailored for individuals, it's not possible to follow aggregate SMA performance in a newspaper or on a Web site.

ALLOCATION

An SMA alone won't provide all the diversification an investor needs. That's because most SMA managers focus on blue-chip stocks. As such, 40% of the investors polled are using SMAs as core holdings, but 11% are supplementing them with stocks and 35% are using mutual funds to cover such asset classes as small-cap, international, and real estate.

BEHAVIOR

SMA investors think they are more disciplined and more likely to stick to their investment plans than mutual fund customers. "SMAs seem to engender better investor behavior," says Mathew Greenwald's Perlman. The survey doesn't examine the reason why. But Perlman suggests that working with a financial adviser can prevent investors from panic selling in volatile markets.

ADVISERS

Wall Street firms' financial advisers like these accounts, too. Over three-quarters said professional management is the biggest benefit. "The job of picking stocks doesn't fall on my shoulders," says Brady Pringle, an adviser at A.G. Edwards () in Tulsa. "That burden falls on somebody who has day-in, day-out experience."

The advisers also say that investors don't understand SMAs as well as they grasp mutual funds. Since these advisers are the intermediaries between the investors and the SMAs, it's clear they have a lot more work to do.

By Lauren Young


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