New players challenge CheckFree’s hegemony in managed acct connectivity. The esoteric world of separately managed account (SMA) operations might not seem an obvious catalyst for change in the advice business. But, by lowering barriers to manager participation and enhancing product offerings, several recent outsourcing deals show how wealth advisors of all stripes might soon be able to offer sophisticated investment solutions that are closely tailored to the needs, goals and tolerances of their high-net-worth clients.

“The point of outsourcing [SMA operations] is to bring down costs and expand product functionality,” says Bevin Crodian, CEO of Market Street Advisors, an Edison, N.J.-based SMA middle- and back-office provider. “This is going to have an enormous impact on the advisory space.”

Busywork

SMA managers seem like obvious candidates for outsourcing. Retail SMAs are tougher to administer than institutional accounts because they’re smaller. That means managers have to fiddle with more of them to achieve profitability. And more accounts mean more account openings, more customization, more reconciliation, more performance analysis and more reporting. In addition, managers are seeing their fees cut as big sponsors like Merrill Lynch and Smith Barney look to reduce their own SMA costs in the wake of expensive platform renovations. Meanwhile, the industry as a whole is growing, forcing more managers to confront critical mass in their back and middle offices. One industry projection has SMA assets growing from around $600 billion at the end of 2004 to about $2 trillion by 2011.

Those things – cost pressures, industry growth and the sheer weight of work – make outsourcing providers think that many managers will give up trying to administer their SMAs and hand them off to specialists.

And the uptake hasn’t been too bad, especially in the last year. Crodian says that an SMA manager needs around $1 billion in assets across roughly 4,000 accounts to make full-on outsourcing economically viable. By this measure about 50 managers in a field of several hundred make the grade. Since 1995 the eight outsourcing providers – Mellon, State Street, the Bank of New York, PFPC, SEI, Citigroup, BISYS and JPMorganChase – have done 21 deals, 11 of them in the past 12 months.

More, please

But some of the very biggest SMA managers are still reluctant to make the leap to outsourcing. One sticking point is control. Operations are critical to an SMA program’s success, so some managers are understandably loath to give them to outsiders. Others wonder if there’s enough to the outsourcing proposition in terms of improved functionality to make it worth their while. “We’ve looked at [operations outsourcers] pretty closely,” says an SMA manager who asked to remain anonymous. “We just think we can do it better [than they can].”

That’s a crucial point to Crodian. “A lack of functionality impairs product design,” he says, pointing to what he views as a divide in outsourcers’ offerings based on their choice of application service providers (ASPs). “Right now the industry remains focused on APL,” he says, referring to CheckFree Investment Services’ middle- and back-office application. That’s a problem, according to Crodian, because APL can’t handle multi-currency transactions and sophisticated fixed-income offerings like asset-backed securities.

CheckFree Investment Services declined to comment. But it’s worth noting that the Jersey City, N.J.-based unit of CheckFree Corporation is working on “EPL,” a new connectivity platform it describes on its website as a “next-generation” version of APL, crafted “to deliver superior business, operational and cost efficiencies to broker-dealer firms, money managers and registered investment advisors.” EPL, now in the beta-testing phase, is scheduled to roll out in 2006. For now though, APL remains the leading SMA platform, providing connectivity to about 80 sponsors and 125 managers, by CheckFree's count.

Seamless

One recent outsourcing deal – Gartmore Global Investments' selection of JPMorgan Worldwide Securities Services – features Vestmark’s portfolio-management software as an alternative to APL may point the way to improved functionality and wider uptake of middle- and back-office outsourcing among SMA managers. And that, say industry players, could mean a broader array of investment solutions for small institutions as well as affluent and high-net-worth clients.

Gartmore went with JPMorgan “mostly because of Vestmark,” says Tim Grugeon, v.p. of business-unit support and outsourcing at the Conshohocken, Pa.-based asset-management company. "The Vestmark platform allows the user to integrate seamlessly with multiple sponsors,” he explains. “That means [the manager doesn't] have to log on to all the sponsors' systems [individually].”

In other words, a manager that uses Vestmark can communicate directly with a sponsor no matter what other connectivity system the sponsor happens to use, including APL. But sources say that APL can only “talk to” APL.

Rob Klapprodt, head of product management at Wakefield, Mass.-based Vestmark, says flexibility was a design consideration for the four-year-old company from the very outset. “Because we’re a new system we have to be able to communicate with whatever the sponsor provides,” he says.

JPMorgan isn't the only SMA operations outsourcer linked with Vestmark. The software maker also provides portfolio management for BISYS' offering. Vestmark also works on the sponsor side. It just signed an agreement to provide overlay technology to independent reps on Linsco/Private Ledger's multi-discipline account platform.

In case of need

Improved functionality is another point in favor of the JPMorgan-Vestmark offering, says Grugeon. For now, JPMorgan is running operations for the small-, mid- and “smid”-cap growth strategies of Gartmore affiliate NorthPointe Capital. But Gartmore took Vestmark’s multi-currency and advanced fixed-income capabilities into account as well. “Whether we utilize [those capabilities] is another matter,” Grugeon says. “Gartmore has managers all over the world, so we always take a global perspective. The JPM-Vestmark platform gives us the flexibility to go where the market dictates,” he says – and the “opportunity to be scalable with growth of assets and with additional managers.”

Stephen Boyle, JPMorgan’s head of SMA outsourcing, sums up his company’s offering as “state of the art. It enables our clients to concentrate on what they do best.”

From an advisor’s perspective, however, improvements in SMA operations might not seem especially germane – unless one happens to have access to an investment platform linked with emergent providers like Vestmark and Market Street Advisors.

But Crodian says that could change, especially if third-party platform providers – such as Lockwood and Brinker – link with more flexible middle- and back-office providers and start pushing more advanced products into the independent-advisor space.

“If you could provide more sophisticated technology, then these more exotic products could be delivered to [registered investment advisors],” says Crodian. “Inefficiencies and lack of functionality in the middle and back office are the main impediment to product innovation in the industry.” –FWR

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