RIAs Take Advantage of Discretion to Launch UMAs and Improve Efficiency

This is a summary from a session of the MMI Tech and Ops Conference with a panel made up of Registered Investment Advisors (RIAs).  The discussions centered around the use of Unified Managed Accounts (UMAs) and the advantages of discretionary versus non-discretionary accounts.


Roger Paradiso, Director/CIO, Managing Director, Morgan Stanley Smith Barney


Dan Sherman, SVP, Family Wealth Director, Morgan Stanley Smith Barney.  Dec 1990, Sherman Group.  They manage over $1 bil in house and advise $2 bil out of house with a seven person team, using a top down method and proprietary financial planning process.

Mark Rogozinski, President, Rockit Solutions, LLC.  They are a back office solution for single and multi-family offices and trust companies.  They are a wholly-owned subsidiary of Rockefeller Financial with around $30 bil in AUM.  Mark has been at RockIt for two years.

Tim Flynn, RIA, President, Tim Flynn LLC.  Currently transitioning from traditional, corporate RIA to a hybrid RIA.  Boutique shop in NYC.  5 people, 3 registered reps and 2 support.  Currently managing $425 mm AUM internally, and $350 mm away, consulting primarily to retirement plans.

Are you using UMA programs and if so, what features do you think are the most useful to your clients?

Rogozinski theorized that all the advantages of UMAs evaporated during the financial crisis, specifically around overlay management and tax efficiency.  Their clients started getting out of UMAs and back into SMAs since there were no longer any embedded gains, which would prohibit them from moving.  Another factor was new technology that Rockit introduced that allows their clients to become their own overlay managers.

In the RIA space, Rockit implemented a new UMA strategy, which is very cost effective and tax efficient, Rogozinski reported.  The new system allows them to service smaller clients at lower thresholds and offer more separate account managers on their platform.  Many firms sold all their UMA assets and switched to mutual funds, since there were no embedded gains after the market crisis.  It’s a very cyclical business and five years from now will probably return to UMAs when the market goes back up and creates new embedded gains, he projected.

Flynn built his practice with open architecture and non-discretionary accounts.   Then he realized that it was expensive and didn’t scale very well.  About 18 months ago, he began to shift his focus to UMAs through two platforms available from his broker-dealer.  UMAs allow him to deploy assets differently, he can run more assets with a smaller staff footprint.  These products have enabled him to become more competitive.

Dan Sherman has seven people on his team at Morgan Stanley, four of whom are partners.   They use a top down financial planning perspective that eventually ends up with an asset management end product.  According to Sherman, they have shifted the bulk of their capital appreciation assets onto their UMA platform.  These assets include more than just equity, but not traditional fixed income.  On the fixed income side, they run a traditional transaction-based business, he said.

What are the key elements of your UMA platform that drive operational efficiency?

The overlay, rebalancing and optimization features of UMA are very helpful, Flynn claimed.  Also, tax harvesting is more automated and reduces the work required by the back office.   From a sales perspective, UMAs are also helpful because their repeatable, scalable processes make them easier to sell.  One feature they would like to have is data aggregation and reporting on held-away assets.  They are also developing proposal and simulation analysis software, he said.

According to Sherman, he and his team at Morgan Stanley are heavy users of Zephyr for asset allocation.  One of the biggest advantages of UMAs is the ability to put SMAs, mutual funds, ETFs and other assets all into the same account, he said.

The ease of use of their UMA platform is a big part of their success, Sherman emphasized.  When they are reviewing managers and alternatives, he explained, they can quickly pull up a screen and view all the core managers in each asset class and see all MPT stats, (such as sharpe ratios, returns, batting averages, etc.) and just click a box to change managers.

Using single advisor contracts and discretion avoids having to call the client every time they want to shift allocations, Sherman insisted.  On a monthly basis, they list all of their UMA accounts (80 total).  The UMA list shows categories of investments, manager name, target allocation and actual allocation for each account.  They then ask a series of questions such as, “Are managers in the top quintile for their genre?”

What do you feel are the advantages of discretionary vs non-discretionary accounts?

Having never worked at a broker-dealer or large institution gives Rogozinski a different perspective.  He has always had discretion, which is similar to most independent advisors, he believes.  Non-discretionary accounts are less efficient and require 20% more headcount, on average, he said.

Operationally, UMA’s are incredibly efficient and reduce operational staff when compared to SMAs, Rogozinski said.  Technology has made UMA easy to offer for independent advisors and family offices.   Most solutions providers can take single custody account with 1,000 holdings and place each one into their own account, segregate them, run performance reports and roll them up again into a household level, he said.

Dan Sherman’s team has discretion and thinks it’s preferable over client’s making investment choices since the investment managers are more qualified to make these decisions.  Discretionary accounts have better rates of return than non-discretionary, he claimed.

Sherman’s claim does have support from data provided by Cerulli, which shows that discretionary accounts outperformed non-discretionary from 2008 through 2010.  They charge more for discretionary accounts (around 0.25% more), which sometimes makes it more difficult to be competitive, he noted.

There are issues related to trade rotation with non-discretionary accounts, Sherman observed.  Which clients should be called first?  He believes that discretion is fairer to all clients.

The advisory business has become a commodity, Flynn said, so they’re using non-discretionary as a selling point for their services.  They use discretion for portfolio rebalancing, but for changing managers or strategic or tactical portfolio weight, they operate in non-discretionary fashion.  They’re taking advantage of the additional client touch points to make them feel as though they’re a partner in managing their own accounts, he explained.

The AUM of discretionary accounts has increased steadily since 2000, as this Dow Jones article reports:

Despite the market meltdown and industry scandals … the trend toward discretionary accounts is expanding in North America, outpacing the growth of nondiscretionary accounts. As of the end of the second quarter, assets placed in adviser-managed discretionary accounts were up nearly 30% from 2007 in the U.S., and 60% in Canada…

Can you talk about some trends in client reporting that you’re seeing?

According to Rogozinski, there’s a huge push in the industry to provide aggregated reporting of assets, no matter where they are held.  This includes both liquid and illiquid assets, including such things as planes, boats, homes, business interests, etc.  Many families don’t understand where their money is, at a detail level.  This was painfully obvious during financial crisis when most client were caught unaware of their total exposure to the real estate market, since it was more than just the house(s) they owned.  Advisors needs the tools to be able to run the analysis and avoid over-concentration of client assets, he insisted.

Dan Sherman has a goal for his firm’s performance reports.  They want to be able to tell clients: here’s how much you started with, here’s what you have now, here’s how much money you made and here’s the rate of return.  Unfortunately, they haven’t been able to truly achieve this, partly due to compliance issues, he said.

Also, they’re forced to show rates of return versus a benchmark, which can sometimes mislead a client as to the true value provided by the advisor, especially when the advisor’s returns aren’t beating the benchmark.  While it’s true that most money managers don’t beat the index, there’s also a lot of money managers whose objective in n0t to beat the index, but to reduce the volatility of their client’s portfolios.

An article titled, “The Case Against Benchmarking” in Financial Advisor Magazine provides a strong argument against advisors using benchmarks.  It quotes Michael Horwitz, of Life Strategies Financial Planning in Austin, Texas, who says:

“Benchmarking puts the focus on the wrong criteria of success: performance relative to an external standard. Instead, the question for an individual client should be something like, ‘What is the most certain way to achieve the 3% real rate of return called for in my retirement projection?’ This type of question puts the emphasis on something the advisor has control over, reducing risk, rather than outperformance, which the advisor has little or no control over.”

Fee-based advisors are incentivized to grow the value of their client’s assets, Sherman emphasized.  Benchmarking should be eliminated since it distracts clients from staying focused on their goals, he said.  For the most part, their clients don’t care which managers they choose.

Rogozinski’s clients are getting pressure from their end clients.  after the past three years of difficult markets, they’re demanding absolute returns over relative returns.  “You can’t eat relative returns,” he noted.

What is your average client size?

A typical client at Rockit Solutions is a single family with a net worth between $500mm-$1.5bil, Rogozinski commented, while their parent firm, Rockefeller Financial, has an average client net worth of $75 mm.  Their clients have historically been separate account users, but over the last 5-7 years, there has been a movement towards consolidation and the use UMA’s have become more prevalent, primarily due to better pricing and flexibility, he explained.

Tim Flynn’s practice is mainly institutional and located on the East coast.  Their average private client has between $5mm-$20 mm in investable assets.

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The Wealth Tech Today blog is published by Craig Iskowitz, founder and CEO of Ezra Group, a boutique consulting firm that caters to banks, broker-dealers, RIA’s, asset managers and the leading vendors in the surrounding #fintech space. He can be reached at craig@ezragroupllc.com