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May 1, 1998

From the May 1998 issue of Entrepreneur

All for one, and one for all. When it comes to wrap fee investment programs, that about sums it up. The term wrap fee program is usually used to describe a number of investment services that are bundled together and covered by a single fee. Unless you’ve been living on a desert island, you’ve probably heard of this kind of investment account, one whose fee includes trading and management costs as well as investment advisory services.

Once the domain of only the wealthiest investors, even the less well-heeled can now participate. So why bother with an account that does it all for you when you can seemingly just as easily do it yourself? If you have the time to follow capital markets nationally and abroad; understand annual reports and analysts’ findings; follow an asset allocation model; and amass enough information on companies of all sizes to make decisions that could affect your financial future, step right up and take a crack at it. (And that’s just for the stock market. Don’t forget the bond market: In case stocks don’t keep going like the Energizer Bunny, you’ll be glad you diversified your holdings.) But if you’d like to know your money is working as hard as you do and still have time to breathe, perhaps a little help wouldn’t be a bad idea.

If you consider that the number of mutual funds investing in stocks is larger than the number of stocks listed on the New York Stock Exchange, you’ll soon realize you have your work cut out for you. Here are answers to some FAQs to help you decide what’s best:

Q: Are wrap accounts for me?

A: That depends on your financial goals and how much money you want to commit. Wrap programs are designed to address the needs of investors who seek professional management of their assets but don’t meet the minimum account size—which, in many cases, exceeds $1 million—associated with the industry’s top investment managers. A wrap program can invest assets in many types of securities, including common stocks; government, municipal or corporate bonds; convertible bonds; preferred stock; and foreign investments.

Q: Why choose a wrap program?

A: In addition to giving you access to the financial industry’s leading investment advisors at lower minimum account sizes, many programs provide objective third-party monitoring of your manager’s performance. Also, to make it on the list of managers working for national brokerage firms, managers must meet minimum standards of legal compliance, assets under management, organizational support, relative performance with a verifiable track record, and investment philosophy.

Q: Isn’t my stockbroker an investment advisor?

A: While your broker may give good investment advice, most retail brokers are registered representatives, not Registered Investment Advisors, who must be registered with the Securities and Exchange Commission. (See Personal Finance, December 1997.) While some brokers provide individual portfolio management on an all-inclusive fee basis, yours is probably not a Registered Investment Advisor. Brokers can introduce an array of independent money managers to their clients with the intent of allowing a manager to personalize a program for them. These managers usually have discretion over all trading in their clients’ accounts. In this case, your broker’s role is to ensure the manager selected is appropriate for your goal. The broker can oversee every aspect of the manager-client relationship, monitoring manager performance and client expectations. Brokers can also recommend firing a manager who is not serving the client’s best interest.

Q: What is the minimum investment?

A: That depends on the type of account you want to establish. Individual managers have different minimum investments, but many equity portfolios begin at $100,000.

Unfortunately, no one manager always outperforms in his or her respective market sector or management discipline. Because of this, most advisors recommend diversifying into several different accounts. In these instances, true account minimums may be closer to $300,000 with total investable assets of at least $500,000. In some cases where mutual funds are used in a bundled account, the minimum is lower. More on this later.

Q: What kind of fees are involved with this type of account?

A: As mentioned earlier, wrap accounts are established on an all-inclusive fee basis, often called, you guessed it, a wrap fee. In some cases, the fee starts at 3 percent for a $100,000 account and decreases as the account value increases. On assets that exceed $5 million, the fee is approximately 1 percent. The wrap fee covers the money manager’s fee, all commissions and transaction costs, ongoing oversight, reviews, and performance-monitoring. There is usually no entrance or exit fee. You are free to terminate the relationship at any time without penalty. Any unused portion of the fee will be returned on a pro-rata basis.

Q: Three percent sounds like a lot. Why not just invest in a mutual fund?

A: At first glance, the average fee is enough to give you vertigo, but think about it carefully. Unless you’re investing in an unmanaged index fund, most funds have management fees and transaction fees that can average 2.5 percent annually. If you buy a fund with a front- or back-end load, your total fees may exceed this average.

Wrap accounts are designed to help you meet your specific financial goals. They take into account your investment style, risk tolerance and need for liquidity, among other things. In contrast, with mutual funds, you’re part of a pool of investors, which offers you two of the very same important benefits offered by separately managed accounts: diversification and professional management. The difference can be seen when the stock market experiences volatility. Here, redemptions by panicky investors may force portfolio managers to sell part of their holdings when prices are low, just to meet redemptions. Individual portfolio managers, on the other hand, can sell stocks when the time seems right; proceeds from these sales can be held as cash or short-term instruments until prices are low enough to buy different stocks at the most advantageous prices.

On the other hand, some wrap programs offer a combination of individually managed and mutual fund wrap accounts that allow investors to reallocate funds between families of funds without charge and at any time.

Q: When I started my business, I rolled the money from my 401(k) plan into an IRA. Can I place this money into a wrap account?

A: For many investors, this is an ideal situation for a wrap account. Because managed accounts trade securities on an individual basis, holding funds in a managed account outside a tax-deferred account can result in a lot of paperwork when April 15 rolls around. With an IRA, capital gains or losses don’t have to be declared on your 1040. Taxes will be paid when funds are distributed and taxed as ordinary income. Remember, these withdrawals may be subject to a 10 percent federal penalty if taken prior to age 591/2. If you pay the manager’s fees directly instead of having them deducted from your investment account, some of this payment may be tax deductible. Consult your tax advisor.

Q: I have a little more than $100,000 in my IRA. If I place it with one manager, will my money be diversified enough?

A: While most managers invest in a number of securities, they may follow just a single discipline. You don’t have to be Julia Child to realize that if you put all your eggs in one basket, you may end up with egg on your face. But don’t give up yet—there’s a wrap fee program just for you. Instead of using one portfolio manager, one style and one account, programs are available to help investors choose from a menu of different mutual funds. Minimums can be as low as $10,000, and the number of funds available to choose from is staggering.

In most cases, mutual fund investors fill out a questionnaire that profiles their investment objectives, time frame, risk tolerance and other issues. Often, a proposal is returned, which recommends allocating the potential investment into stock and bond funds. Stock funds are often divided into market sectors (large-, medium- and small-company stock funds), style (value and growth), and origin (domestic or foreign). Bond funds are divided into corporate, government, foreign and other areas, depending on the program you choose and your investment objective.

Many programs will reallocate funds on a quarterly or annual basis to keep your preferred allocation in line, selling shares of funds that have performed well and buying those that have underperformed. In addition, many programs provide access to load and no-load funds, and allow investors to switch not only between funds but between families without incurring a sales charge. Fees for this type of account typically begin in the 1.25 percent to 1.5 percent range and may decrease as assets under management increase.

Before you get involved, get a copy of the offering statement and the prospectuses of the funds you’d like to employ. Remember, professional money management is not suitable for everyone. And that’s a wrap.

Lorayne Fiorillo is a financial advisor at Prudential Securities Inc. For more information, write to her in care of Entrepreneur, 2392 Morse Ave. Irvine, CA 92614. Past performance is no guarantee of future returns.