How do you explain to your clients about using a SAM?

We frequently hear this question from advisors: How do I explain to my clients that they should use a bond manager when we've been managing the bonds?

A portfolio of individual securities can be a tax-efficient and customized alternative to a mutual fund. In the past, advisors were able to add value because the cost of using a separate account manager was too high. With a decline in the cost of using a separate account manager, they have become an option for advisors to use for their clients instead of doing it themselves. The firm Evensky & Katz came to this conclusion in 2003 (see Harold Evensky's May 6th, 2003 article entitled, Why Hire a Manager to Pick Your Bonds? This article can be found here. Currently, this article can only be downloaded with Internet Explorer; We are sorry for the inconvenience). Below, we discuss the fees, specialization, value added, and validity of separately managed accounts.

Fees

Just as mutual funds charge fees, so do separate account managers. The separate account manager directly states the fees charged, while mutual funds disclose their fees in the prospectus. Mutual funds deduct their fees before they report performance and the client does not see the exact amount. If the investor is using a separately managed account, the investor pays fees to the manager and they are more transparent. Separately managed account fees were relatively high in the past (in the neighborhood of 1.5-2.0+%), but now they are very competitive (.25-.50+%) in comparison with mutual funds.

Specialization

Bond portfolio managers have lower transaction costs than the typical advisor. They also have access to other beneficial tools such as Bloomberg not usually utilized by an advisor. There is a great deal of specialized knowledge and detailed work that goes into managing bond portfolios. A professional money manager is able to do things that even a good advisor doesn't do.

Value Added

The cost/benefit analysis for using a separate account manager is much more favorable today than it was in the past. Customization and tax-efficiency are the main reasons to use Separately Managed Accounts. These benefits are difficult to achieve using a mutual fund. Value-adds from a SAM can compensate for the cost of professional management. In the past, separately managed accounts were marketed as customized when they were really 'expensive closet mutual funds' according to Evensky. The competition has increased over time with SMA's and money managers are discovering more ways to add value to a client's portfolio. Harold Evensky places the value of active bond management in a SMA at .10-.30% net of fees. Tax management may provide additional value to the client's portfolio as seen in the chart below.



Validity

Harold Evensky, a nationally renowned financial planner with Evensky & Katz Wealth Management in Coral Gables, FL, had this to say about altering his bond strategy: "(C)hanges in the economy led us to believe in spite of our expertise, our strategy of individual bond selection was no longer in our clients' best interests." The cost effective strategy of a bond separate account manager became available and Harold made the switch.

Conclusion

While the advisor may have done a good job in the past managing the client's bond portfolio, declining fees of separate account managers have created the opportunity to increase after-tax performance for the client. This allows the advisor to focus on managing the relationship with the client and free up time to work on other tasks.