Stuart Daly, a broadcasting executive who lives in New York, admits feeling pretty "smug" about his investing acumen. Three years ago, he signed up with a private money manager, Brandes Investment Partners, through Dean Witter Reynolds' fee-based consulting service, and has enjoyed returns averaging 21% a year.
Does he care that Dean Witter charges as much as 3% a year for what is known as a wrap account? Not with those kinds of returns, though he concedes it will hurt to pay the fee (which he negotiated down) if he doesn't make any money this year. "But look, I'm not naive," Daly says. "I know there are ups and downs in the market, and I'm confident it will recover, given some patience."
Daly certainly doesn't sound like a dupe. But he has bought one of the most controversial--and fastest-growing--financial programs of the '90s. To make sure he and every other investor who buy a wrap account know what they're getting into, federal regulators recently issued new consumer-disclosure rules. As of Oct. 1, program sponsors must supply new brochures to prospective wrap-fee clients. Among other points, the documents must state that the program may cost more than it would have if the investor had bought the services separately.
Wrap accounts are offered by all the largest brokerages as well as many smaller broker-dealers, banks, and mutual-fund firms. In them, brokers, often renamed "investment advisers" or "financial consultants," match clients with private money managers (or, increasingly, mutual funds), shaving as much as 3% of assets a year to cover the manager's fee, all transaction charges, and the ongoing advice and account monitoring that brokers provide.
MOVING ASSETS. That may sound like a lot of service for one fee--and it may be well worth the price, depending on how much help you need and get from your broker and how actively traded your account is. But the bottom line is that most people are paying the fee year after year for a range of services they may only need the first year. If you just want professional money management, you should be able to get it more economically by purchasing a mutual fund, even if you pay a one-time sales charge of 4% or 5% for a broker to help you pick one.
The many critics of wrap programs have been arguing just that for years, and yet money has flowed into the programs at an even faster rate than into mutual funds. Assets grew 45% from Mar. 31, 1993, to Mar. 31, 1994, according to Cerulli Associates, a Boston financial-consulting firm, and show no signs of slowing down despite the current market volatility. In contrast, mutual funds grew at a rate of about 25%, and asset flows slowed as soon as the markets got dicey.
But the Securities & Exchange Commission has been watching wraps closely for years and, though there have been few complaints from investors, it passed rules creating the new brochure on Apr. 19. Securities firms claim they provide this information already but admit it wasn't all in one place in an easy-to-digest format. "They're just repackaging the disclosure," says Richard Grabish, manager of AG Edwards' private and business client services.
The document is designed to make sure consumers understand the full scope of the programs and get the service they are paying for. But they may prove most useful for people who are comparing programs. Firms now have to address directly a few key areas that have inspired the most criticism.
First and foremost: fees. The brochure will do more than lay out the fee schedule. It will state what portion goes to the money manager--usually about 1%. For investors attracted to the program primarily because of the appeal of obtaining a private money manager, it will be clear that the bulk of the fee goes to the brokerage firm.
MAKE A DEAL. Sponsors are required to say if the fees are negotiable. Brokers often reduce the 3% stated fee for large accounts or under pressure from the investor. In fact, the average fee is about 2.3%, says Cerulli Associates. So if the brochure says the fees are negotiable, negotiate.
The brochure will also say if there are hidden fees. These are probably not significant but are worth knowing about. For example, if a private manager has part of the portfolio in a money-market fund, the investor will still have to pay the fund's costs.
Another area of contention is how the broker goes about choosing the money manager. Disclosure required in the brochures explains how portfolio managers are chosen to participate in the firm's program, and from that limited list, specific ones are selected for clients. Firms should have "due diligence" systems set up to monitor these managers, and you can use this section in the brochure to compare programs. Find out under what conditions the firm will replace a manager. Check to see if they conduct their own research or buy it from outside companies. Before you choose a program, ask to see a sample report on a manager so you can compare the quality and thoroughness of the research.
Firms must also disclose how the manager's performance numbers are calculated. Total-return figures in private money management are notoriously easy to play with, and there are no universally used standards for reporting performance numbers as there are with mutual funds. Money managers are famous for cherry-picking their best accounts or justifying poor performance by comparing their numbers to some obscure index. If the firm does not use the same standards to calculate returns for all managers, the brochures require they say so. Be wary of these numbers in any case.
A key nugget of disclosure lets investors know they have a right to consult directly with the money manager. If there are restrictions, the firm must spell them out. For example, you may have to contact your broker before going to the manager. The brochure will also tell you how much information about you will be passed on to the money manager. This will give you an idea just how "individualized" your account can be. If you don't intend to seek personal attention, you might as well be in a mutual fund.
Wrap programs make clear sense in some cases. First, if there is a private money manager you like, it may be the only way you can have access to his or her services. Many such managers require a minimum account size of $1 million, while the wrap programs often have a $100,000 minimum. (The programs that use mutual-fund managers may have minimums as low as $25,000.) Another reason to go into a wrap program is to maintain a close working relationship with a particular broker without worrying about getting nickel-and-dimed on transaction charges.
ON GUARD. Whatever you do--make sure your broker is qualified. This is one area the SEC's brochure did not address, so you will have to ask some questions yourself. Avoid brokers who do less than 35% of their business in fee-based consulting programs or who haven't been involved in this area for at least seven years, recommends Bert Meem, an investment management consultant with Dean Witter in New York.
Ask them what additional training they have received in asset allocation and portfolio management. Two industry groups have developed professional designations earned only after undergoing training and passing tests. If brokers boast a CIMC (Certified Investment Management Consultant) or CIMA (Certified Investment Management Analyst), you can at least be sure they are committed to this line `f business.
As the new brochures will make clear, wrap-fee investors are paying for personalized investment advice. If that's what you want, make sure you get it. If you don't, make sure you're not paying extra for it.
--What percentage of your business comes from providing fee-based consulting services? (Should be at least 35%.)
--How long have you been in this line of business? (Should be seven years or more.)
--What ongoing support, research, and oversight does your firm provide?
--Can I see a sample research report on a money manager to see how thorough your firm is?
--What additional training have you received both from your firm and from outside sources?
--Have you obtained any professional designations? Accreditations, such as Certified Investment Management Consultant (CIMC) or Certified Investment Management Analyst (CIMA), are catching on.
DATA: BUSINESS WEEK
WHAT THE NEW BROCHURES WILL TELL YOU
--The program's fee schedule, including what portion goes to the money manager and whether the fee is negotiable or there are hidden charges.
--How the portfolio managers are selected and reviewed, and the circumstances under which they will be replaced if they don't perform as expected.
--How the performance numbers you've been given were calculated, and whether the firm used a uniform standard for measuring returns of all managers.
--If the program sponsor places any restrictions on your freedom to contact your money manager, such as requiring you to call your broker first.
--What information about you and your investment goals the firm will pass on to the money manager and how often it will be updated.