Dissatisfied with his portfolio's lackluster returns, Long Island entrepreneur Sandy Kane fired his stockbroker and hired a private money manager who promised to deliver superior performance. Four years and an equal number of managers later, the 54-year-old owner of a sales-promotion business is still wondering whether having his own money manager has been worth it.
Like Kane, most investors choose a money manager with one grand goal in mind: to achieve consistent killer returns. But the biggest mistake many investors make is blindly focusing on performance while ignoring investment style and tax efficiency, according to Len Reinhart, chairman of Lockwood Financial Group in Malvern, Pa., which handles both mutual funds and separately managed accounts. It's easy to present strong numbers in a bull market, but performance results are often deceptive. Typically, a firm's prospective clients are shown the numbers in a one-size-fits-all "model portfolio," which may bear little resemblance to your own account. And it may not even be run by the manager with whom you will invest.
"REAL MONEY." Most separately managed accounts require a minimum investment of $100,000 and are best suited for investors with large taxable accounts who have specialized investment needs. But critics question how much attention that amount of money will buy. "It's hard to believe that someone with even a $1 million portfolio thinks they're going to get that much personalized service," says Harold R. Evensky, a financial planner in Coral Gables, Fla. "Real money begins at $100 million for these managers." Armed, however, with a modicum of knowledge, even those who have little more than the minimum can find a competent manager.
Think of a privately managed account as your own personalized mutual fund, run by someone whose full-time job is buying and selling securities. Contrast that with plain-vanilla brokers who spend a good portion of their day drumming up business and servicing clients. Proponents of separately managed accounts claim that they are more tax-efficient than mutual funds, since the manager can time the sale and purchase of securities to match your needs.
Unless you dig beneath a manager's returns and fees--typically 1% to 3% of the assets under management--most privately managed accounts look the same. By asking the right questions, you substantially narrow the universe of qualified managers, thereby increasing the chances that you'll end up with the kind of customization you require.
You may want to begin by asking a financial planner for a referral. Financial planners and money managers both provide investment advice, but a financial planner takes a more global approach to your finances. The International Association for Financial Planning (800 945-4237), Institute of Certified Financial Planners (800 282-7526), or National Association of Personal Financial Advisors (888 333-6659) can refer you to a planner in your area who will recommend qualified money managers. An extra precaution: For $39, the National Fraud Exchange (800 822-0416, ext. 33) will do a comprehensive background check on an adviser.
TAILORED APPROACH. Of course, you'll want to examine the firm itself. How long has it been in business? How much experience does it have with individual investors? Many firms cater to institutional clients. Too often, the attractive performance numbers you are shown apply only to the firm's institutional tax-free portfolios, says Brian Berris, a partner at Brown Brothers Harriman & Co. in New York. "Find out how much of the assets under management are similar to your own," he adds.
Many institutional firms have a model portfolio that they use for all accounts. The best money managers take a more tailored approach. Ask who will be making the individual buy-and-sell decisions for your account. An account statement with an odd number of shares may be a sign that you are not getting personalized attention, says Evensky. The reason: Most managers buy in round lots: Therefore, an odd number may mean that the manager plugged your account into a computer model and divvied up your assets among its holdings.
Once you are satisfied with a firm, turn your attention to the individual manager. The first step is to request the ADV form that firms and advisers are required to submit to the Securities & Exchange Commission, says Tony Sagami, marketing director at AdvisorLink, a money-management evaluation service in Austin, Tex. Part 1 of this form can reveal any skeletons (bankruptcies, investment-related civil or criminal judgments, etc.) in a manager's background. Part 2 provides background on the firm and discloses any egregious compliance problems. Firms are required to give you ADV Part 2, but you'll get Part 1 only if you ask.
Only now is it time to focus on the performance numbers. While the Association for Investment Management & Research has developed guidelines encouraging managers of taxable portfolios to report their pre- and post-tax results, most firms only show pretax numbers. "Few people have any idea how important that tax drag can be on their portfolio," Berris says. One indication of tax efficiency is low portfolio turnover, but it is important to ascertain what additional strategies the firm and the manager have to promote favorable aftertax performance. For example, a tax-savvy manager may invest in stocks where most of the return comes from capital appreciation, taxable at 28%--vs. stocks with high dividends, taxable annually at as much as 39.6%.
Yet just comparing the numbers on a tax basis isn't enough. You need to find out what they represent. "There's a great range of latitude taken by managers to use the performance composite that looks best," Berris says. A prospective client may be shown performance numbers from one "star" manager or carefully chosen accounts.
CLUNKER. If the numbers you are shown represent a composite, ask for the dispersion, or range, of the highest and lowest returns among the firm's money managers, advises Heidi Steiger, director of the Individual Asset Management division of Neuberger & Berman in New York. If dispersion is low, selecting one portfolio manager over another may have little impact on your account's performance. And if it's high, you could end up with a clunker. Ask the firm where the manager who will be handling your account is ranked. If you're not satisfied, go elsewhere.
As always, your best defense is to read the fine print or footnotes on all data you get your hands on. "Look at a firm's performance track record," Sagami suggests. And, adds Steiger: "Find out why the firm chose that particular time period."
No matter what the time frame is, however, make certain that you understand how much risk the manager took in order to achieve those returns. Remember to check a manager's performance in bear as well as bull markets. Start by having the firm break down the overall return by asset class. Then check the return for each class against its relevant benchmark or index. For example, compare the large-cap portion of the manager's return with the Standard & Poor's 500-stock index during the same period.
Always ask for a range of performance results from best to worst across various time periods and compare the results with the appropriate benchmark. A good manager will describe the risk-reward profile of the benchmark in question and why it is relevant to your own account.
Once you are actually assigned to a money manager, find out how many other portfolios that person oversees. It is not uncommon for managers within the private banking
departments of commercial banks to manage well over 200 accounts. You must decide how little attention you are willing to accept if your manager runs numerous portfolios.
Part of the allure of a separately managed account is having one of the best investment minds in the business at your personal disposal. But unless you take the time to ask the right questions, you'll end up with little more than a glorified--and rather expensive--mutual fund.