Three years ago, tax lawyer and entrepreneur Theresa Fette was not expecting to become the CEO of one of the most successful trust firms in Nevada.

Today, she’s running Las Vegas-based Provident Trust Group, which has evolved into a $750 million trust company. The average trust account is in the $50 million range, the company is inking huge 1031 exchange deals and high-end lawyers from around the country keep calling in to place assets.

All of this comes from an opportunity that fell into place two years ago when Trust Company of the Pacific (TCP) lost its trust license after getting on the wrong side of the Nevada banking regulator.

When TCP’s owner P. Sterling Kerr, a prominent Las Vegas attorney, saw the writing on the wall, he contacted Fette and made a deal to sell all 7,000 of his company’s now-refugee accounts—crown jewels valued at nearly $300 million—to her group.

The problem was that Fette had no immediate home for the accounts. As a tax lawyer, she could not just pull a trust charter out of her hat, but after lining up a holding company and support from the Nevada banking regulator, within a few months Provident Trust was up and running.

With some of the best and the brightest people in the industry on her team and 7,000 accounts already in place, there was no question the day the operation opened its doors, it was pulling a handsome profit.

Today, Fette is not too shy about discussing the enormous success her trust firm has experienced after that jump start. Having more than doubled its assets under administration, Provident has also expanded its trust product offering to include retirement accounts, alternative assets and the highly sought-after Nevada asset protection trusts.

The Trust Advisor Blog asked Steve Oshins, one of Nevada’s best-known estate planning attorneys, if he had ever heard of Fette and Provident. He said no.

“In a small community of Las Vegas, you’d think we’d know each other, considering that we’re both in the same industry,” he says. “But she’s obviously smart because she contacted you to gain attention for her trust firm’s success story.”

Networking is key

Provident has kept a fairly low profile because just keeping up with word of mouth has kept the team busy.

“There really hasn’t been any advertising,” Fette says. “We network with members of the legal and financial advisory community and that’s our biggest source of referrals.”

One big plus with the advisors: As a strictly directed trust operation, Provident Trust doesn’t offer in-house wealth management services, so there’s no worry that it will try to poach client assets.

“We see all the trouble come when people try to dip their hands in too many buckets,” she says. “And how truly independent can a trustee be if you’re also managing money?”

Good point! And for many trust firms wrestling with conflicts of interest and unbundling trust fees to comply with Knight vs Commissioner, she might be right on the money.

Speaking of networking, Fette is one of the younger members of the trust community. A few months ago, the M&A Advisor Network flew her to Los Angeles for a black tie gala to honor her and other under-40 movers and shakers in the advisory world.

Flat fee for small accounts

We found one aspect of Provident’s business model especially intriguing. Under their self-directed IRA banner, they take relatively small-sized accounts ranging from $50,000 to $100,000.

This is not the norm for most trust firms, which tend to prospect for accounts north of $5 million. Provident’s key to success is charging these relatively low-maintenance IRA customers a flat $395 a year for providing custody service no matter how much—or how little—money is in the account.

Naturally, for a $50 million dynasty trust, $395 per year wouldn’t work, but Provident’s normal basis point billing structure ensures that taking care of those larger accounts remains a profitable enterprise.

When you work the math out, 8,000 accounts times $395 means you’re billing over $3 million a year. And in a world where retirement accounts are relatively dormant most of the time, both risk and turnover are comparatively low.

With ideas like that, coupled with the team’s stellar reputation, it’s clear that Provident will be well over $1 billion in assets shortly.

Scott Martin, contributing editor, The Trust Advisor Blog. Jerry Cooper and Steven Maimes contributed to the research and reporting.

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On the surface, this should be an exciting time to manage trust assets. The universe of available options has expanded well beyond old-fashioned blue-chip companies and Treasury bonds to include hedge funds, private equity, foreign stocks and other once-exotic offerings.

But even with this expanded menu to choose from, today’s portfolio managers just sigh when you ask them where they’re finding sources of income for their trust clients.

“There’s a complete dearth of income on a worldwide basis right now,” says Michael Mullaney, who helps run $8 billion for Boston-based Fiduciary Trust.

“The dividends and the Treasury yields just aren’t there,” he added. “And many of the things that look good on paper are actually value traps.”

Fiduciary Trust addresses the problem by allocating some client funds to alternative products like hedge fund shares, private equity and other limited partnerships that generally provide higher returns than bonds and retail funds.

Unfortunately, trusts are not exempt from the rules restricting these products to “accredited” investors with substantial assets. An irrevocable trust needs over $5 million to buy into a private equity fund, for example.

Smaller trusts can buy shares of publicly traded private equity firms like Blackstone Group, but it isn’t quite the same as getting directly into the funds, Mullaney explains.

Similar building blocks, slightly better returns

Minus the alternative asset classes, modern trust portfolios still look a lot like any other high-net-worth retail account.

Modern portfolio theory rules apply, New York estate planner Martin Shenkman explains.

This means that if beneficiaries or the trust documents need a certain level of income, the manager tinkers with the allocations to provide that steady disbursement at the lowest level of risk. Otherwise, the goal is usually to maximize returns while keeping risk in the beneficiary’s and trustee’s overall comfort zone.

Either way, index funds provide core market exposure, freeing the manager to concentrate on hard-to-cover areas like municipal bonds or small-cap stocks.

Unless a firm can find enough investments in these areas to justify its fees, Mullaney says it makes more sense to just put everything in low-cost funds or ETFs and let the asset allocation do the heavy lifting.

A firm like Pennsylvania-based HBK Sorce, for example, will designate a mix of retail funds from a wide variety of vendors, including Goldman Sachs, Invesco AIM, American Funds and even no-load shops like Vanguard.

The perils of proprietary product

Many trust companies that are affiliated with larger banks or wealth management firms still reach first for in-house products to fill a particular portfolio bucket.

For example, Great Plains Trust, which we profiled a few weeks ago, loads its trust accounts with proprietary Buffalo mutual funds and collective investment trusts built by corporate parent Kornitzer Capital Management.

But other banks, stung by Wall Street scandal, are moving to more open platforms where managers can mix proprietary and third-party products in the same portfolio.

Part of the motive here is defensive. Wells Fargo’s trust department is just one high-profile recipient of a long-running class action suit that argues that filling a trust with in-house product is not only a conflict of interest but self-dealing.

Opening up to other vendors’ best ideas can also give a trust company a competitive edge. This is the logic behind the rise of overlay investment models in today’s cutting-edge wealth management shops.

“We have a client that is actively competing on the fact that it has everyone’s ideas to choose from,” Jerry Michael, CEO of overlay provider Smartleaf, tells me.

“It proves that they’re not just selling product, but choosing the best solutions for their fiduciary clients.”

Allocations remain conservative

Wherever the underlying assets come from, asset allocation is still 90% of the game, Martin Shenkman says.

Although the ideal trust portfolio has evolved beyond the age-old “60% in General Electric and everything else in laddered Treasury paper” split, many managers haven’t moved very far.

It’s true that the Prudent Investor Act altered the playing field by requiring trustees to modernize their portfolio theory and invest more actively to get their clients a higher total return. But core allocations remain highly conservative.

The typical trust account only increased its stock allocation by a whopping 1 to 5 percentage points after the Prudent Investor Act, according to trust industry gurus Robert Sitkoff of Harvard and Max Schanzenbach of Northwestern University. (Read the report here.)

This doesn’t mean that trust companies are just locking in a 63%/37% asset class split for all clients. Every account is different, they stress.

Depending on the trust’s goals, an aggressive total return strategy could result in a 35% large-cap stock allocation, a 20% bond allocation and the other 45% in more speculative asset classes.

While more conservative strategies still hug that 60%/40% line, the current market climate has some managers adding new ultra-conservative options for their trust clients.

“In 2008, even our most conservative portfolios lost 10% to 13%,” says Michael Mullaney of Fiduciary Trust. “So we created an even more heavily risk-tested version that cut volatility in half. Client quite frankly love it.”

Scott Martin, contributing editor, The Trust Advisor Blog. Steven Maimes contributed to the research and reporting.

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The economic pinch has even affected paradise. Hawaii is suffering from a decline in tourists and as a result is scrambling for new ways to bring more money to the state. Ambitious plans are underway that include the revival of the 1970s hit CBS TV show “Hawaii Five-O.”

As part of the revival initiatives, Hawaii’s trust firms and the estate planners have embarked on a bold campaign to attract the world’s super rich by making it the premier trust haven of the Pacific.

On June 28, 2010, Hawaii Governor Linda Lingle signed into law a new trust law designed to compete with Nevada, Delaware, Alaska, South Dakota and other domestic asset protection trust states by allowing local trusts to shield assets from creditors or, theoretically, the courts.

With the new law, Act 182, as ammunition, local legislators hope their state will become a powerful “sun, swim and protect” combo that entices mega-rich families who may be vacationing in paradise to leave more of their cash behind.

“We believe that trust business is very compatible with our visitor industry,” explains state senator Rosalyn “Roz” Baker, who sponsored the bill back in January.

“Yes, the rationale was to woo offshore assets to a repository in Hawaii,” she adds.

DEAD ON ARRIVAL

Even though Honolulu is optimistic that asset protection trusts will bring in revenue, estate planners do not see a credible threat to established trust centers on the mainland.

Although Act 182 puts Hawaii ahead of the 37 states that do not support asset protection trusts at all, unique twists ensure that the Aloha State will remain a poor second choice compared to other asset protection states

Under the new law, wealthy families must pay an unprecedented 1% excise tax on all money and assets they move into an asset protection trust.

Given the potential size of these accounts, this can add up to real cash for the state government—but why would anyone pay it if a few phone calls to Nevada, Delaware or South Dakota will provide the same benefits without the added charge?

“The law won’t work as intended,” says Dan Rubin, a prominent estate planning attorney with the New York firm of Moses and Singer.

“Without very bad legal advice, no smart billionaire is going to set up a trust in Hawaii even if they have a $10 million house on the beach if it requires participants to pay a 1% user fee to gain trust benefits.”

If the extra expense weren’t enough, Hawaii also restricts asset protection trusts to 25% of the grantor’s net worth—and prohibits transfers of real property into trust.

And unlike states like South Dakota or Nevada, trusts administered in Hawaii pay state income tax whether their trustees are locals or tourists.

Someone in Hawaii must have done some quick math to work out a formula for political success. According the state’s 2010 budget, Hawaii only had a $22.3 million shortfall. Therefore, if say only a few billionaires set up a handful of trusts, with a 1% excise tax, $3 billion would do the trick and generate $30 million in tax collections.

Finally, while Honolulu may hope Tiger Woods or other celebrities with contentious marriages will start flying in for sun, golf and protection, Act 182 does not shield assets from divorce—or even secured creditors.

Steve Oshins, a Nevada asset protection trust lawyer who rates asset protection trust states based on their benefits, agrees with Rubin that the new law is “dead on arrival.”

“I don’t even know if it’s got a lot of sizzle, let alone the steak,” he says. “Nobody’s going to use it.”

In fact, he gives Hawaii a failing grade where asset protection is concerned, and would be surprised if the new law will help the Aloha State carve out even 1% of the business currently dominated by Nevada, Alaska, South Dakota and Delaware.

“Laws need to be competitive with those of the Tier 1 states,” he explains. “Given the ability to forum-shop, nearly everybody from out of state uses one of these four states.”

NOT FOR TIGER WOODS…BUT WHAT ABOUT THE LOCALS?

With reviews like these, the state’s three institutions with trust powers—Bank of Hawaii, Central Pacific Bank and First Hawaiian Bank—may not win many accounts from the mainland after all.

Bank of Hawaii, far and away the biggest of the trio, does substantial trust business with locals, but so far this year its trust and asset management income has been flat or even slightly lower on a year-over-year basis.

Resident estate planners doubt that the new law will even give Hawaiian professionals and other wealthy residents an incentive to keep their assets at home.

“Now that I’ve chewed through this a bit more, I’m moderately certain we won’t use many of these,” says Hawaii-born financial planner Lesley Brey.

“I suspect that it will not be very appealing to most professionals,” agrees Honolulu estate planning attorney Ethan Okura. “I see no reason to keep marketable securities with a trustee in-state.”

In fact, Okura believes that only relatively “unsophisticated” locals will take advantage of the new ability to create an in-state asset protection trust.

“Many local Hawaii residents prefer to work with other local professionals, so perhaps there will be quite a few who utilize the new law—especially if the local banks promote it with their clients,” he says.

Dan Rubin predicts the Hawaiian legislature to wake up to Act 182’s problems and start fixing them fairly soon.

But for Hawaii to become a real national competitor, just putting asset protection on the menu is not going to be enough, Steve Oshins says.

“Because they have a state income tax, they wouldn’t have a chance,” he says. “If you had the best state law, then you can say that you’re going to charge a little more because you’re the best. But this is a mediocre law anyway.”

Perhaps the revival of the TV show Hawaii-50 may have the same good luck it did 40 years ago and attract tons of tourists to the islands. But for now, as Dan Rubin says “if this were 1997 and Hawaii introduced the first domestic asset protection statute, this law might be taken seriously.” He adds, “but this is 13 years later, and wealthy families expect a lot better.”

Jerry Cooper, senior editor, The Trust Advisor Blog. Steven Maimes and Scott Martin contributed to the research and reporting.

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Overland Park-based Great Plains Trust has become the second established trust company this year to file the paperwork to transfer to the bustling jurisdiction of South Dakota.

According to the South Dakota Division of Banking, Great Plains—which claims over $1 billion in fiduciary assets—applied for a trust charter in July.

In June, Denver-based United Western Trust got its South Dakota charter. General counsel Ted Abariotes tells The Trust Advisor that the rationale was pretty simple.

“We just couldn’t find all the compelling benefits that South Dakota has to offer anywhere else,” he says.

Restarts are popular

United Western and Great Plains are only the leading edge of a record-breaking wave of 11 out-of-state trust companies starting in or moving to South Dakota this year.

Applicants are coming from as far away as Pennsylvania, and even include institutions based in states like Nevada that are normally considered centers of the trust industry in their own right.

Seven have received their charters so far, while Great Plains and three others are pending. If they all get approval from the Division of Banking, it would bring the state’s roster of trust companies to well above 50, compared to 40 in Delaware and 25 in Nevada.

As a result, trust services have become big business in the trust-friendly state. South Dakota booked a record $262,651 in trust-oriented revenue last year in the form of examination and supervision fees.

Great Plains trust officer Michael Sears wouldn’t speculate about the appeal of South Dakota or his company’s motivations for letting go of the Kansas charter it had held since 1994.

However, local estate planners are pretty sure Great Plains, like United Western before it, is going to South Dakota in order to give clients access to trust structures and tax breaks they couldn’t get at home.

“I can easily see the upside,” says Sam Scott, a financial planner at Sunrise Advisors who does a fair bit of trust work. “There are some scenarios where the move to South Dakota jurisdiction could save a Kansas client quite a bit of money.”

Taxes and flexibility

First and foremost, moving the trust administration out of state translates into freedom from Kansas income tax liability, Scott explains. Because South Dakota has no state income tax, this immediately generates 6.45% a year in extra income for beneficiaries.

Beyond that, South Dakota provides a retail-oriented trust company like Great Plains with much wider flexibility in the types of account structures it can offer.

Kansas doesn’t even support total return trusts, Scott says. Especially in the current rate-squeezed environment, shifting clients who need cash flow out of state-mandated income-only accounts could go a long way toward improving their lifestyles and making them happier.

When asked to speculate why Great Plains might be moving, Northwestern University law professor Max Schanzenbach—who has studied state-versus-state competition for trust company business in partnership with Harvard professor Robert Sitkoff—went immediately to the chance to offer perpetual trusts and asset protection trusts.

South Dakota and a few other states allow trusts to operate forever, unlike Kansas, where the amount of time wealth can remain in trust is capped at 21 years after the death of the last original beneficiary.

And while neighboring Missouri, where Great Plains has been operating as a fiduciary since 2006, allows domestic asset protection trusts, moving the primary charter will help the company offer these increasingly popular products to all of its clients.

Kansas doesn’t offer them, but South Dakota, Nevada, Delaware and nine other relatively trust-friendly states do.

Asset protection trusts aren’t just for celebrities looking to shield their wealth from a divorce decree, says Rick Kahler, a financial planner based in Rapid City, South Dakota.

“Doctors and other business owners also appreciate the protection,” he explains. “The power to block any distribution is a unique benefit and they’re pretty simple to put in place.”

Putting favorable statutes behind a local face

Max Schanzenbach rattles off a few other reasons why a trust company might move to South Dakota—favorable private trust laws, franchise tax or regulatory oversight issues, the chance to move closer to the state’s banking community.

Compared to Delaware and Nevada, the barriers to entry in South Dakota for a start-up are relatively low. While capital requirements can climb at regulators’ discretion, a new company only needs to post $200,000 for a South Dakota charter, versus up to $1 million elsewhere.

However, the key motivators for established institutions like Great Plains usually boil down to tax benefits and flexibility.

As Schanzenbach’s research with Robert Sitkoff revealed, about $100 billion in fiduciary assets shifted out of states like Kansas to tax-friendly asset protection jurisdictions like South Dakota between 1995 and 2003, and the trend seems to be continuing.

In fact, Kansas planner Sam Scott cites similar reasons for why he sets up his clients’ trusts through Charles Schwab’s Delaware-chartered trust company.

“Kansas is a state where it can be easy to get around some of the things you need to get around,” he explains.

“And let’s face it, as long as you have someone on the ground where your clients live, nobody knows where your charter is. It could be in Alaska.”

Scott Martin, contributing editor, The Trust Advisor Blog. Steven Maimes contributed to the research and the editing.

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When industry research firm Cerulli Associates released its latest benchmarking report on unified managed accounts (UMAs), the headlines screamed that advisors just weren’t buying into these theoretically advisor-friendly investment vehicles.

According to Cerulli analyst Jeff Strange, less than half of the financial advisors he surveyed have ever used unified management accounts and roughly 80% have no plans to rely on UMAs more in the future.

“They still don’t understand why UMA is beneficial to their process,” Strange tells the Trust Advisor. “A big part of that is still just that the providers haven’t taken off the training wheels yet.”

While about $80 billion is now managed on UMA platforms, new flows have been stubborn to capture. Only $1.7 billion in new money came to UMAs in 2008 and while aggregate AUM in these vehicles jumped 70% in 2009, most of that growth was simple appreciation in a bull market year.

Overlay providers fire back

Statistics like that are frustrating for companies that sell UMA software and investment models on the premise that UMAs are better for trust companies, banks and advisors than either traditional mutual funds or separately managed accounts (SMAs).

Both UMAs and SMAs tap the expertise of third-party managers to build a customized investment portfolio. However, while an SMA exports the assets to the outside managers to run, UMA assets never leave the sight of the bank or advisor that landed the client in the first place. Instead, the UMA imports the manager’s expertise and applies it to the assets in what’s called an “overlay.”

Trust officers and other advisors can then tinker with the overlay to improve tax efficiency, balance out clients’ outside holdings or obey restrictions against investing in various types of companies—tobacco, for example.

While the combination of flexibility, best-of-breed investment models and custody of the underlying assets should be a win with advisors, most overlay providers still have well under 100 clients on their platforms.

But those narrow client lists—and the Cerulli data—disguise the fact that while the typical RIA may not be eager to sign up, the institutions that are adopting overlay approaches tend to be banks and other relatively big wealth managers.

While a vendor like Smartleaf may only have about 50 clients running its overlays, those elite four dozen institutions still manage about $31 billion in AUM between them. This effectively makes Smartleaf the leader in the bank UMA marketplace.

Most of our clients are banks now, says Smartleaf president Jerry Michael. And many of those banks are pretty big names like BB&T, BBVA Compass and, most recently, Bank of Hawaii’s $6 billion investment services group.

Scale is a big part of the UMA value proposition. Specialized vendors like Smartleaf (which provides the back office software that supports these accounts) and Placemark (which gathers the proprietary investment models) cater to firms that already have accounting systems, trading systems and the dedicated IT staff to keep them talking to each other.

Resellers like Concord Wealth Management and others, package and resell Smartleaf with enhancements into an integrated solution for smaller players like the archetypal independent broker fresh out of the wirehouse.

If you’ve got 100 clients, you can probably build them customized portfolios yourself. But as Placemark CEO Lee Chertavian tells me, going the overlay route looks a lot more cost-effective if you’re running $5 billion in 13,000 client accounts.

“Overlay management can be as simple as an accounting solution to combine separately managed assets or as complicated as a system that helps an institution make better investment decisions,” he explains. “We’re on the far end.”

The real buyers don’t need to be sold

Banks that have the scale and the sophistication to benefit from true UMA programs rarely need much of a sales pitch, Smartleaf’s Jerry Michael says.

“Often as not, they approach us,” he notes. “Firms with strategic objectives requiring change tend to see it as a must-have product. Firms looking for incremental improvement are more reluctant.”

The ability to bring in outside expertise while retaining ultimate discretion is especially attractive for trust companies and other fiduciaries, Michael says. Farming out the assets in an SMA approach rubbed too many banks—not to mention RIAs reluctant to “share” their hard-won clients—the wrong way.

“SMAs just didn’t work for banks,” he explains. “They like being fiduciaries. They wanted to remain fiduciaries, but they needed to open up their wealth management to outside research. This lets them have their cake and eat it.”

Of course, concentrating on the bank channel contains its own challenges. The only client Smartleaf has lost in its 10-year history was when Regions Financial bought Union Planters and threw out its UMA systems.

That’s true of the advisor channel as well. Jeff Strange at Cerulli acknowledges that much of advisors’ distrust for UMAs comes from the notion that overlays are not portable from one broker-dealer to another, and too complex for the typical independent operator to run on his own.

“You can take the mutual funds and the underlying securities with you, but the tax management and other features are not transferable,” he says. “Same with the specific mix of asset managers you have running the portfolio.”

For Jerry Michael, the important thing is clearing up the vagueness surrounding these accounts and what they do.

“I personally twinge when I hear the word UMA,” he says. “It’s too confusing.”

“There’s one type of UMA that’s really just a souped-up SMA that helps the institution monitor what the outside managers are doing in all the separate accounts. Then there’s what we do, where the outside managers’ brainpower is brought in to sit on that truly unified internal account.”

Scott Martin, contributing editor, The Trust Advisor Blog. Steven Maimes contributed to the research and the editing.

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