Tracking the Elusive Private Accounts

Privately managed accounts are different animals from mutual funds. They have distinct tax features, fee structures, and disclosure requirements. Because of these disparities, following them is a challenge. But fund tracker Morningstar has risen to the occasion, creating a database of about 2,200 private accounts, about half the total number. "We're still in the build-up phase," says Ryan Tagal, Morningstar's product manager.

Right now, the database has a few kinks, and ironing them out will not be easy. The biggest problem is how managers report returns. Private accounts can disclose two types of returns--gross and net. Gross returns don't deduct management fees, which can range from 3% of assets for the smallest accounts to 1% for the largest. Still, gross returns are important because they show the manager's investment acumen. Of course, no investor actually earns the gross return.

Net returns have problems, too. "Quite a few money managers don't [publish] net returns for their accounts, and when they do, they take the maximum fee out and deduct that from the gross," says Tagal. Such a statistic would be useful for only the smallest accounts that pay the highest fees. So Morningstar does not publish net returns.

The validity of the information collected is another problem. The Securities & Exchange Commission does not subject private accounts to the same disclosure requirements as mutual funds. For instance, the accounts don't have to file annual reports with the SEC. Many managers follow a reporting standard set up by the Association for Investment Management & Research, a nonprofit industry group, but its rules are for performance only.

Because of the lack of reliable public information, Morningstar collects data using questionnaires filled out by account managers. But that can lead to errors. For instance, the database reported 28.3% 10-year gross annualized returns for accounts in the Astor Long-Short Program as of Sept. 30 instead of the actual 23.1%, because Astor inserted the information for the wrong product by mistake. BusinessWeek found performance-related errors with two other firms.

A big selling point of many private accounts is their ability to be customized to reduce capital-gains distributions for tax-averse investors. Morningstar's manual data collection causes snags here as well. If the manager doesn't fill out a portion of the questionnaire, the database reports that they do not offer customization. "Not all firms fill out the survey completely," says Tagal.

Although the database has its drawbacks, it has great potential to shine light on a murky area. As Morningstar works out the kinks, that light should become clear enough for investors to distinguish between good and bad private accounts.

By Lewis Braham

    Before it's here, it's on the Bloomberg Terminal.