Opinion

The Unexpected Rise of Fixed Income SMAs

March 22, 2012

Mark Elzweig is president and founder of the executive search firm Mark Elzweig Company.

Separately managed account managers that oversee fixed income assets have momentum on their side. Traditionally, advisors would choose separate account managers for only their stock-picking prowess, and many advisors viewed utilizing a manager for fixed income assets as a redundancy. After all, most advisors were perfectly capable of laddering their own muni bond portfolios and selecting their own corporates. There was simply no need to pay an outside manager for that service. But, as with so many other things on Wall Street, the 2008 crash changed all that. BlackRock, the largest SMA manager, with $51.2 billion in SMA assets under management as of Dec. 31, managed about 70% equities and 30% fixed income in 2006, after it acquired Merrill Lynch Investment Management. Today, those percentages have nearly reversed, with 60% of BlackRocks business now in fixed income, as reported. This breakdown is not unique to BlackRock. For the industry as a whole, management of municipal and taxable SMA portfolios has jumped from 29% of total SMA assets in the fourth quarter of 2008 to 45% in the fourth quarter of 2011, data provided by Dover

Financial Research shows. Cerulli Associates data, meanwhile, shows a 120% increase in SMA fixed income assets from 2007 through the end of 2010. Sales credits on fixed income trades dont fully explain why brokerage advisors are handing off fixed income investments. Its the fallibility of the rating agencies. Commissions on bonds have been falling for some time to just 25 bps to 50 bps on short-term maturities, down from 3% to 3.5% in the 1980s. But the agencies have had a bad run this century, and advisors arent so sure they can rely on the guidance of rating agencies in selecting bonds for their clients. Advisors, and indeed the investment community at large, remember all too well how Moodys, S&P and Fitch all rated Enrons bonds as investment grade until just four days before the companys collapse in 2001. The rating agencies were not any savvier in their assessment of WorldCom and other epic frauds. Werent these the same guys who mistakenly thought that subprime junk could be magically transformed by securitization into CDOs with AAA-rated tranches? Clearly, many advisors have concluded that they need the serious, credible fixed income due diligence that asset managers can provide. Numerous industry insiders view rating agency research as largely stale, after-the-fact pronouncements on information that has already been out there for a while. The scarcity of municipal inventory has also strengthened the hand of fixed income SMA managers. Securities Industry and Financial Markets Association data show that municipal issuance plummeted from $429.3 billion in 2007 to only $294.6 billion in 2011, a 31% drop. Some municipalities have either already maxed out their borrowing capacity or are in such poor financial shape that they dont dare come to market with new bond issues. Asset managers can often buy blocks of bonds at more favorable institutional prices. They may have access to inventory that wirehouse advisors never see. For example, suppose a small hospital comes out with a $20 million new issue. That paper may be snapped up entirely by one or two asset managers. The dramatic decline in the number of insured municipal bonds from 45% in 2007 to 5% in 2011 has also made advisors more inclined to seek out professional fixed income mangers to help them navigate credit risk. This isnt a passing trend. Advisors of all stripes will continue to recognize for years to come the value that quality fixed income managers can add even without the doomsday scenarios of analyst Meredith Whitney hanging over the marketplace.

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