Unified managed accounts were introduced to address a number of issues, including providing oversight of multiple styles, access to high-quality portfolio management guidance at a lower investment minimum, the simplicity of a single account, and a reduced enrollment effort. The implementation of trading under an overlay manager – with the resulting avoidance of wash sales, cross-style tax-lot selection, account-level sector and risk analysis – all represent benefits for the investor.
Still, a UMA can compromise some of the benefits of individual management and separately managed accounts (SMAs). The level and degree of the impact is difficult to assess, but many UMA support teams have to explain the reason for any divergence of a portfolio manager’s style from published SMA or mutual fund performance returns.
While UMA programs vary in their level of automation and distribution of discretion, we are assuming a high level of automation, with the overlay manager making all monitoring and trade decisions. In cases where the overlay manager shares discretion with certain kinds of portfolio managers, the issue of dilution is less of a concern, though. Such a so-called hybrid UMA is generally limited to fixed income and small-cap styles. That notwithstanding, the contribution of equity portfolio management in a UMA program is still less compared with one in which the manager has full control over investment management.
The following are aspects of UMA management that impact the contribution of the asset manager:
- The timing and frequency of trade implementation matter. Portfolio managers provide models to the UMA program to fulfill contractual terms, sometimes even daily. The moment of the receipt of the model, the period in which the overlay manager reviews and includes the model in the rebalancing application, and the frequency of rebalancing are all factors that impact the resulting investment moves in individual accounts. In some cases, specific target trading also has an impact.
- Portfolio managers generally provide style models or investment management to several managed account programs – SMAs, matched sale-purchase agreements (MSPAs or system MSPs), UMAs and mutual funds. Allowing for rotation among programs, portfolio managers provide new or changed models as soon as they make their investment guidance decision. The timing impact in a UMA, as described above, will influence the actual experience of individual investors.
- The thoroughness of rebalancing asset allocation, styles and model changes varies from one UMA program to another. Rebalancing is applied with different levels of thoroughness across UMA programs, depending upon the chosen guidelines. Some programs will rebalance at all levels every day, while others will do so only when out of alignment with their asset allocation. Others will rebalance a given style when it goes beyond the identified style definition or specific security target. Still other programs will identify changes to the model from the previous submission, and enact targeted trading of only those changes, leaving the balance of the style, asset allocation or overall account unreviewed.
Of course, periodic rebalancing brings accounts into alignment. Monitoring by the overlay manager also identifies significant issues. Nonetheless, divergence from the guidance of the original portfolio manager’s recommendations likely will result.
Differences in the depth of investment analysis and choice may crop up. In developing a model, the portfolio manager incorporates his or her entire view of the markets, including any anticipated movement, the value of individual securities, sector implications, risk aspects and timing. For those portfolios wholly under their management, portfolio managers make decisions with consideration of individual investors when conditions or events merit changes in timing or substitution of securities.
This traditional level of oversight and judgment is in the hands of the overlay manager in a UMA program. Unless the portfolio managers are consulted, the overlay manager’s resulting decisions may not align with the choices of the portfolio manager. UMA programs have evolved, if only
partially, to embrace the efficiencies of common practices, and dealing with exceptions affects the level of efficiency and the costs of the program.
A successful UMA program should follow the overlay manager’s judgment. The overlay manager is responsible for identifying opportunities and conflicts among the many style portfolio managers in a UMA program. The sophistication and creativity of their responses will necessarily influence trading decisions.
Portfolio managers undergo thorough and repeated vetting by UMA sponsors, other managed account programs and investors. Yet, beyond providing a model, in a UMA they cannot apply the same rigor and skill that they do when they control all aspects of the investment decision-making process. This is the nature of a UMA program, and should be considered when weighing its costs and benefits.
Originally published on FundFire.com.
11 June 2012