Cerulli survey says wealth managers don’t understand and aren’t buying UMA overlay capabilities. One firm, Smartleaf, bucks the trend and continues to close deal after deal. Here’s why.

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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