Point of View

Breaking away from convention to reimagine unified managed accounts

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Unified Managed Accounts (UMAs) have emerged to improve operational efficiencies and simplify delivery to the client. Many early UMAs were built on legacy, multi-style portfolio (MSP) platforms. This means that underneath the same multi-account limitations continue. One such limitation is a highly complex sleeve accounting system (for multiple sleeves within a UMA) that often inhibits the ability to effectively manage the investor’s portfolio, creates significant processing overhead and undermines the credibility of the UMA sleeve performance as a meaningful measure. If the industry is to realize the expected benefits of UMAs, the role of the sleeve needs to evolve to align with the goals of the UMA.

UMAs and Unified Managed Households (UMHs) have been touted as holistic investment management structures that combine diverse research ideas to meet investor goals. In short, they should produce better results than the sum of their parts. When managing holistically, decisions made within a sleeve may differ from the decisions that would be made were each sleeve considered in a silo. This approach raises questions as to what is the value of sleeve accounting for UMA and UMH portfolios.

Sleeves prior to the UMA

The UMA (and UMH) is a vehicle for bringing together various ideas into a single account in what should be an efficient delivery model. The MSP was an earlier attempt to deliver open architecture and consisted of multiple styles in a portfolio, primarily delivered through separately managed accounts. Using legacy platforms, each style was managed as a separate sleeve. Sleeve accounting was a natural byproduct of account-level performance.

While the MSP provided the investor with open architecture, this multi-account approach was cumbersome to adjust overall allocations across accounts. In addition to operational difficulties, security overlap between managers could lead to wash sales as one manager sells and another re-buys. In addition, lot selection for sells were not tax optimized. For instance, if manager A sells a holding using the most tax efficient lot (say, a small short-term loss), manager B may maintain the same position at a short-term loss. In an attempt to remedy these issues, the UMA emerged to improve operational delivery and overall management across sleeves.

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Sleeves in early UMA platforms

Many of the early UMAs were built upon legacy MSP platforms to allow quick time-to-market for the advisor. This meant that, operationally, the same multi-account limitations continued. On many platforms, sleeve accounting was maintained to preserve the manager-level performance—often with great complexity. Many platforms perform full sleeve accounting as often this is inherent in legacy technology where a UMA is aggregated from individual accounts, each representing a sleeve. The aggregation can be difficult, particularly when assigning cash from various sources such as dividends, contributions, and withdrawals. The partitions created to do full accounting often inhibit the ability to manage the investor’s portfolio and can create significant processing overhead. Some argue that sleeve accounting is necessary to calculate sleeve performance. However, if all of the complexities can be overcome in the legacy environment, the question remains: Is UMA sleeve performance a meaningful measure?

For example, a UMA portfolio owns security ABC. ABC has appreciated briskly and is now significantly over the target at a level of 9% against a target of 5%. The holding is shared by two manager models and the overlay manager is looking to bring the position back to 5%. The best tax lots to sell reside in manager B’s portfolio with a target allocation of 4% so the full position is sold. The overlay manager has created dispersion in the manager B sleeve with an impact on performance. However, this is the optimal action at the overall portfolio level. Judging manager B’s results based on sleeve performance, in this case, is not valid. Alternatively, faux trades could be created to ease the impact, but this is often not automated and operationally intensive. In this scenario, the manager is not realizing the full benefit of a UMA structure due to the sleeve reporting process.

Moving sleeve reporting forward

A sleeve does have a role in defining a portfolio’s target allocations. The percentages are maintained to measure portfolio drift to trigger points when the manager model should be traded to bring the portfolio closer to its target. The target represents the contribution of the manager model to the overall asset allocation.

However, there is no reason to consider a standalone sleeve when performing overlay portfolio management. If two manager models contain the same equity stock, then the target for that stock is the sum of the two targets at an overall portfolio level. That position can now be managed against a single target with all trading decisions made against a full set of lots for that overall position. This approach allows the asset allocation to become more efficient as cash is pooled and can be managed at the overall portfolio level more efficiently.

One of the main arguments against this approach relates to performance measurement and reporting and how underperforming managers can be identified. Most managers do not include their UMA manager models in their composites due to overlay impacts. However, to really understand portfolio performance, it makes sense to look at the performance of the manager model. With this approach, the impact of client-specific tax management and client-specific cash flows do not alter the true manager model performance and the true value of the model can be measured. This can be done through a standalone portfolio or by using composite returns for the manager strategy.

The investor can then understand the before and after tax performance of each model with the delta between overall portfolio performance being attributed to overlay management and customer-specific behavior related to cash flows. Traditional sleeve accounting does not allow the investor to understand the specific impacts of their behavior and overlay as each sleeve reports a single performance number that includes all of these disparate factors.

Benefits to breaking away from the conventional view

This approach has two main advantages. The investor is able to understand portfolio performance as a whole and the drivers of that performance by looking at model versus overlay/customer behavior impacts. Also critical is that technology can now reflect what the UMA/UMH purports to accomplish—unified management within a single account. The technology design no longer needs to contemplate the artificial partitions to achieve sleeve-level performance which in a true UMA environment loses relevance.

While the UMA has proven to be a useful tool for managers throughout the industry, the underlying processes and technology prevent it from realizing its true potential. By reimagining the operating model for sleeve accounting, managers will be able to offer their investors greater transparency while decreasing overhead which will benefit investors and advisors alike.

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