Dominant Vendor, CheckFree, Gets Competition From DST.
By all accounts, it's a big business and getting bigger every day. Separately managed accounts (SMAs) are the new investment vehicle of choice for those with at least $100,000 on their hands and a wish for more personalized investment attention. As such, money is flooding into SMAs, drained mostly from mutual funds, by the millions. Almost every consultant in the land is saying that the growth potential of SMAs is staggering, that is, if certain technological and operational difficulties are addressed before their effect becomes prohibitive.
SMAs are individual client portfolios which follow a predetermined model but can be customized by restricting certain investment instruments, according to a client's wishes. They are very attractive to the average investor because, with a minimum of only $100,000, individuals can have their money managed by professional, institutional money managers.
Making all this possible are trading and portfolio-accounting systems which allow managers to handle thousands of accounts simultaneously while still allowing for some customization and personalized tax treatment.
The SMA business, much like the industry in general, can be broken down between the buy side and the sell side. In this case, however, it's the sell side, or the large wirehouses, which seem to have the upper hand.
The largest wirehouses, like Merrill Lynch, Salomon Smith Barney, Paine Webber, Prudential and Morgan Stanley collect the assets from the public using their retail operations or a third-party distributor. From there, they look at their list of 40 or 50 asset managers and match up a client's investment objectives with one or more of the managers on their roster.
The funds in an SMA world are never transferred to the manager but rather reside with the sponsor or the sponsors custodians who keep track of the account's inventory and cash balance, reconciling that information with the manager's records.
Operational difficulties arise because investment managers, who wish to be players in the SMA business, must connect with multiple sponsors and four of the top five sponsors each require managers to use their particular SMA platform. Paine Webber, Salomon Smith Barney, Morgan Stanley and Prudential all require participating managers to adopt the platforms they have created. Merrill Lynch does not specify which system its managers need to be on (75 percent use CheckFree). That creates a situation where managers have to interact with multiple systems just to do business.
To make matters worse for asset managers, they no longer have the choice of opting out of the SMA game. Forrester Research estimates that by 2004, assets in this space will grow 400 percent to reach $870 billion.
The key to success in the SMA-platform business lies in vendors establishing electronic connections with sponsor firms. Selling an asset manager a system without them is akin to providing a hydrant with no hose. CheckFree, which dominates the market, has built its empire off those connections, currently boasting links to 38 of the top 50 SMA sponsors and 36 of the top 40 managers.
But everything is not peachy in CheckFree land, nor in the industry as a whole. As usual in the financial-services arena, proprietary systems are the obstruction to operational efficiencies.
CheckFree's dominance in the field has much to do with its longevity. The company was one of the first technology vendors to show an interest in the SMA space over 20 years ago and therefore had the jump on competitors focused on other areas of financial services. But some clients say that CheckFree has taken advantage of its market dominance, letting its customer service slip while prices rise.
"It's no secret that there is sort of a love/hate relationship and they (CheckFree) recognize it," says Greg Horn, CEO of Advisorport, an investment-consulting platform vendor and CheckFree client. "CheckFree, because of their market share, operates a little bit like a monopoly and therefore it is tough to get the kind of pricing levels you really would like and what you think are fair. To get resources from CheckFree, sometimes it really depends on how big you are."
Horn is not alone. Tim Henry, chief operating office with Brinker Capital, a SMA-plan sponsor that uses CheckFree technology, says that although he is satisfied overall with CheckFree, he is not a fan of the company's pricing structure.
CheckFree, he says, charges its customers on a per-account basis, not according to assets under management, the prevalent method of assessing payment in the financial-services industry. Because of that, says Henry, an economic downturn, such as the current one, means Brinker's income off SMA accounts is reduced while their payments to CheckFree stay the same.
"I've said to them at conferences that you have to think about your price," he says. "In years where the market is going down, they look pretty expensive."
Hilary Fiorella, a vice president with CheckFree, says when analyzing CheckFree's pricing, it's important to consider that the company provides an outsourced service, meaning CheckFree must maintain all the hardware and software to run the system, while client's are only responsible for hooking up to the platform, something which can be done through T1 lines, VPNs, point-to-point connections or an Internet dial-up.
"If you do an apples to oranges comparison we look expensive but if you do the cost/benefit analysis then we are pretty reasonable," says Fiorella.
What many in the SMA space don't find reasonable is having few places to take their SMA-technology business.
"Those problems (pricing) only matter if there is another viable competitor and right now there isn't," says Jamie Punishill, a senior analyst with Forrester Research.
But that may be changing. Though a few other small players dwell in CheckFree's shadows, a new player has entered the space which could change the landscape: DST.
DST, with its experience in the mutual-fund world and transfer-agency business believes it has the technology, experience and connections to give CheckFree a run for the SMA money. In fact, DST Product Manager Roger Gregory says his company's first order of business is establishing the technology connections with the largest SMA sponsors.
"Our goal is to develop interfaces to all sponsor organizations," says Gregory.
And, in a not so veiled challenge to CheckFree, he adds, "We plan on implementing new players and converting managers off their existing applications."
DST plans to go after the incumbent CheckFree on price as well. "We think that because they have been so dominant, they have not been as competitive as they could in terms of their pricing," adds Gregory. "We think we can come in lower."
John Payne, a consultant with Cerulli Associates, a firm which follows the SMA business closely, says DST has the potential to shake things up. "We think that if anybody has the resources and connections to establish interfaces to the leading sponsors, it's DST. If they can establish these robust interfaces we believe they will challenge CheckFree's dominance of the marketplace."
For the time being, CheckFree continues to dominate the market and Fiorella says there are plans in the works to improve the customer service and technical support the company provides. She says that by the end of this year the help desk will be divided between those with a high level of expertise to expedite more difficult calls and newer representatives who will only field basic inquiries.
Also, CheckFree is launching a browser-based venue for customers to query against, rather than relying on the text-based methods which currently exist.
For the foreseeable future, most sources say CheckFree will continue to dominate the marketplace for two reasons: first, it is no mean feat to switch SMA-platform providers and secondly, despite any complaints, CheckFree works.
Payne adds, "Though the managers love to hate APL (CheckFree), it works 90 percent of the time."