Avoiding the Wrap Trap

How to help clients get the most from separate account management.

July 24, 2008

An interview with Paul M. Guerney, CFA, Portfolio Manager, Rochdale Investment Management. The interview was conducted by John T. Fulgham, AIF, Senior Vice President of Rochdale Investment Management.

Designed for wealthier investors as the next step beyond mutual funds, separately managed accounts offer the promise of holdings transparency, tax control and more. However, these benefits usually are not fully realized, as the typical wrap platform does not address the real world needs of most high-net-worth clients, such as existing positions, cash flow requirements, risk concerns and communication.

Q: Paul, prior to joining Rochdale a number of years ago, you were with a well-known separate account advisory platform provider. Why do you think wrap accounts are so popular?

A: There are three main points that marketers of wrap accounts use. The first is that you know what you own, as opposed to a mutual fund where youre blind to the holdings. This was a particularly interesting point back in the days of the tech bubble. There was a large demand for viewing stocks that were running up.

The second and probably more important point is tax consideration. When you purchase a separately managed wrap account, you are purchasing all the stocks individually in your personal account. Therefore, you dont share in that collective gain that a mutual fund might distribute. You also may have the ability to do some tax loss selling, but usually its very limited.

The third benefit is that there are certain restrictions that can be placed on an account, such as not owning sin stocks like tobacco or firearms. I find that most of the time this is a much underutilized feature, but it is a positive one relative to mutual funds.

Q: You mentioned transparency as a benefit, since the client knows what they own versus a mutual fund. This should give them a greater sense of control, right?

A: It has been my experience that you dont necessarily want to see all your holdings because of the sheer number of them. Over the last several years, we have had a significant number of new clients that have come from wrap platforms. Typically what youll find is four or five managers, each one operating independently with a 50-, 60- or 100-stock portfolio. The large number of holdings in most wrap accounts can make it challenging even for the most astute investor or advisor to determine whether the portfolio meets the intended goals. My experience has been that its very difficult to see the big picture and what is going on in the overall portfolio regarding each stocks role in the portfolio or the volatility you can expect. Moreover, the burden of monitoring and coordinating among the managers may detract from time available to focus on higher-level issues like the clients asset allocation, estate plan and overall financial well-being, as well as broader asset gathering for business development.

Q: Lets dig a little deeper into restrictions. How would a wrap manager typically implement a restriction?

A: Typically, if the portfolio is going to be 100 stocks and you place a restriction that eliminates 25 of those stocks, the remaining 75 simply will be overweighted. The wrap manager simply will omit those holdings versus identifying an acceptable alternative that still provides the client with the proper risk and return exposure for the intended asset class.

Q: The ability to control taxes is one of the much talked about positives of separate account management. But the transition into wrap accounts can be a problem. Most clients do not have all cash to start. What happens to a clients existing holdings?

A: The transition into wrap accounts typically requires liquidation, immediately or over a couple of days at most, regardless of individual preferences or tax implications. They may keep existing holdings that are already on their buy list, but even then youre forced to conform exactly to the proportion all the other clients have for that holding. On an ongoing basis, ability for targeted tax loss selling is hampered by limited manager access.

Q: Many advisors already have clients that are in wrap accounts. How should they go about evaluating their current wrap account relationship and what appropriate barometers should they be using to judge performance and some of these other things you talked about?

A: I think you have to take a look across those accounts: Has there been any overlap in these accounts, what styles and strategies are they pursuing and are they sticking to those styles and strategies? We do a lot of objective analysis for advisors, using our sophisticated analytical tools and systems to do the cash flow, volatility and sector/industry analysis and also to assess performance relative to an appropriate custom benchmark. Its very challenging for an advisor or client to look on their own at that across the entire portfolio.

Q: Compare and contrast how Rochdale approaches separate accounts differently than what investors might receive in a wrap program.

A: Portfolios at Rochdale are truly handcrafted separately managed accounts. You have direct access to the people making daily investment decisions on the clients behalf. We dont outsource the research or portfolio management, so we have a coordinated approach to the complete portfolio. We understand the asset allocation, the client, the goals, the cash flow requirements, and the constraints if there are any and tax considerations. We identify how to complement existing holdings while transitioning the portfolio over time. There really is no limit to what we can do in customizing an account for an individual. There are other places that will do it, but only if you are among the extremely high-net-worth individuals. Goldman Sachs will do this for you if you have $20 million or $30 million with them. Families with substantial money do it all the time, but its very difficult to find this service at the $1 million-, $2 million- and $3 million-level as Rochdale does.

Q: I’d like to re-emphasize a couple of key points that you said; that each portfolio you manage is completely individual. You really dont have a model portfolio that you hand off to anybody that comes in the door today, tomorrow or next week.

A: Even if two clients come to us with 100 percent cash on the same day, their portfolios could be very different based on their individual risk profiles, cash flow needs, volatility parameters, tax restrictions and other criteria. This level of customization is not possible in a wrap program. We dont like to turn something over just because its not in the exact stock or right proportion we want. We make individual recommendations for each client.

Q: You mentioned something the term direct access. What you mean by that, of course, is a direct line of communication between client, advisor and you as portfolio manager, which is extremely unique in this business. How do you find that the direct line of communication benefits the client and the advisor?

A: We are able to discuss and review all of the aspects of the clients portfolio and what has happened to all the stocks that are in their various accounts. We know the timing of those purchases, why it was being done and the reasoning behind everything. Our research teams are here in the same office and understand what the different companies do and how they fit into a portfolio context. That really is the driver of the portfolio returns, the portfolio volatility, all of those things that you need to know as an individual when youre making an investment.

In a wrap program, most of the time, you can’t really ask, What would be the impact if I decided to sell these ten stocks for tax losses? What do you think about the timing of that? When should we do it: today, tomorrow, next week or next month? What’s your outlook? That’s very difficult to do without a customized portfolio and direct access to the portfolio manager.

The portfolio manager acts as a sounding board, in some ways, for clients and advisors. We can give guidance and really lay out the details and the pros and cons of anything that they are thinking about doing from a portfolio perspective and their financial health in general. Its so much more effective for the individuals risk management and their comfort level.

Paul M. Guerney, CFA, is a Portfolio Manager with Rochdale Investment Management. a private client money manager specializing in personalized portfolio management for high net worth individuals and families. For more information or for a confidential analysis of a clients portfolio, please call Patrick J. Vignone, CPA, at 800-245-9888 or e-mail info@rochdale.com .

This publication is for informational purposes only and is not intended to be a solicitation, offering or recommendation by Rochdale or its affiliates of any product, transaction or service, including securities transactions and investment management or advisory services. The opinions expressed in this publication should not be considered investment, tax, legal or other advice and should not be relied on in making any investment or other decision.