Many commentators have described LPL’s purchase of investment management outsourcing firm Fortigent as a straightforward bid to muscle into the high-net-worth market.

After all, some of America’s biggest advisory firms rely on Fortigent to help them run about $50 billion in client accounts.

But while Reuters was quick to characterize this deal as a naked grab for “higher-end clients,” it’s lot more strategic than bolting on high-quality assets.

Remember, LPL is best known as a commission shop, but it’s already an unheralded but unarguably massive player in the RIA space as well.

Their nearly 13,000 advisors have accumulated $96 billion in fee-based AUM. That’s more than the top 20 fee-only advisory firms in the RIA Database, put together.

Dig down, and it’s less about the assets than the architecture. And the writing’s been on the wall for months.

All the keys to the open architecture platform 

When we first heard about the Fortigent deal, we thought back to April, when LPL paid $20 million for relatively obscure software provider Concord Wealth Management.

Concord’s technology helps financial firms that use the “overlay” approach manage their relationships with third-party investment managers.

The outside managers pick the securities, the client-facing advisors pick the managers and software like Concord’s keeps everything straight.

And as it happens, Fortigent picks the managers — or at least does the research and makes recommendations on who’s good and who’s not worth bothering with.

Now that LPL owns both companies, it has all the pieces it needs to offer affiliated advisors a true “outsourced” asset protection platform even though all the important functions can be handled in house.

Concord provides the back office support from proposal to billing. Fortigent can populate the platform with its universe of pre-approved managers.

And in theory, LPL reps can spend a lot less time building client portfolios themselves — and a lot more time keeping existing clients happy while prospecting for new business.

“LPL is now unique as an outsource organization,” Aite Group analyst Sophie Schmitt told me back when the Concord deal closed.

Now, LPL is obviously capitalizing on what she calls “intense interest in open architecture solutions.”

“This creates plenty of new expansion opportunities,” she explains.

This might be why Ron Carson, LPL’s top producer, recently brought his $3 billion in client assets back to the firm after leaving back in May.

Carson left because he wanted to run his own fund. A fully integrated overlay system can give him the next best thing by letting him distribute his “model” portfolios to every other advisor out there.

When he came back to LPL a few weeks ago, he said the firm was working on “one of the most exciting technologies I’ve anticipated in a long time.”

A completely in-house open architecture platform definitely seems to fit that bill.

Custody is part of the equation

LPL can also package Fortigent’s manager research to sell back to Concord’s bank-and-trust-heavy clientele.

At the time, LPL raised eyebrows by touting Concord as its toehold in the personal trust custody space, but the synergies weren’t obvious.

LPL is already a major player in bank-resident brokerage services through its UVEST subsidiary, which runs the investment programs for 300 banks and credit unions and supports about 2,300 advisors.

With Fortigent’s managers on the table, these institutions can now outsource their entire investment operation — including the trust portfolios — to LPL and its affiliates.

That’s a sales pitch that cost-conscious bankers are going to be a lot more eager to listen to, especially if it means more time for their in-house personnel to court new accounts.

“It’s obviously very beneficial from a cost savings perspective,” Schmitt says.

Since Fortigent supports unified managed account (UMA) structures and various alternative asset classes, it seems a natural fit as an outsourced solution for trust portfolios in particular.

With a UMA structure, the introducing institution never gives up custody of the underlying assets, but instead simply imports and “overlays” the third-party models to determine how to invest its clients’ wealth.

This overcomes some of the traditional stumbling blocks of separately managed account (SMA) approaches in the trust space.

Meanwhile, the asset-class-neutral UMA structure ensures that real estate, private equity and any other “legacy” alternative assets held in trust can coexist with stocks, bonds, mutual funds and anything else the investment managers and grantors desire.

Which overlay provider is next?

With all these opportunities opening up, LPL executives may not even feel the need to expand much into the high-net-worth advisory market in the near term.

After all, that’s what its independent reps are for. And the banking opportunities look even more seductive — if you connect all the dots.

The question is really how much LPL paid for Fortigent. We’ll find that out in a few months when the company reports its next quarterly numbers.

But if the $10 billion on Concord’s platform brought a price of $20 million, Fortigent  — which runs five times that much money — may have cost at least as much.

Will other overlay vendors become takeover targets? We’ve been covering this space for awhile, so you can get a sense of some of the players here.

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

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When the parent company of independent brokerage firm LPL Financial announced last week that it is buying overlay technology vendor Concord Capital Partners, the brokerage community cheered.

But the mood in the banking channel was a lot more subdued.

Concord had built its business — about $10 billion under administration for 70 institutions, according to a company press release – on the proposition that its investment platform was completely free from any whiff of preference for one wealth manager over another.

(For an overview of how overlay UMA systems work, click here.)

Thankfully,  LPL has no proprietary product to push at Concord’s clients, but it has aggressively built out its clearing and custody business over the years.

Once the deal closes later this year, Concord will be formally tied into that platform at least on a corporate level. That’s enough to get some of its customers reviewing their options, competitors say.

“Some may have issues down the road with how the new parent company wants them to handle their trust assets,” says Joseph Mrak, CEO of overlay firm Folio Dynamix.

“It all depends on how LPL integrates the existing clients into its own platform,” he adds.

Custody is the key here

Independent custody has been one of the selling points of the overlay management approach, and Concord may have lost that, whether LPL has proprietary funds to sell or not.

“Concord’s big advantage is that they’ve been independent with no requirement to use their trading and custody providers in order to do business,” says Kelly Coughlin, CEO of competing overlay firm GlobalBridge.

“Now that LPL is on the scene in order for them to harvest true value from this acquisition, they’re likely going push trading and custody arrangements with LPL, perhaps as a condition of doing business,” he added.

“Those arrangements could in turn translate into higher costs for Concord’s customers, potentially denigration of service and possible conflicts of interest,” Coughlin remarked.

Clients are owed the duty of best execution. In this case, LPL may not offer the best performance at the best cost with a sea of trading and custody vendors able to offer a better deal.

With an overlay system, trust companies and other institutions can farm out the job of determining how the underlying assets in an account are invested, but while investment ideas flow into the portfolio, the assets themselves stay right where they are.

This is especially valuable for fiduciaries, which have a regulatory obligation to have their clients’ funds under their control at all times.

Initially at least, LPL says Concord and its clients will continue on exactly as they have.

But in practice, anything can happen, says Sophie Schmitt, a senior analyst at the Aite Group, which covers the financial industry.

“We just don’t know yet what they’re thinking at LPL, but it is clear that they are absolutely looking to take these outsourced solutions to new markets,” she says.

LPL CEO Mark Casady might have tipped his hand in his company’s recent quarterly earnings call by saying that he’s “very excited about the cross-selling potential” that Concord provides his broker-dealer network.

“It creates new expansion opportunities, giving us the ability to custody personal trust assets for banks throughout the country.”

For new clients, that “cross-selling” may be welcome as a way to get an integrated one-stop wealth management, brokerage and trust services solution.

Sophie Schmitt, for example, suspects that LPL is going to use Concord as a way to tap into the mid-tier banks that are too low on the industry feeding chain to do all their investment management in-house, but high enough up the industry feeding chain to benefit from an outsourced solution.

However, Concord’s existing clients may not take kindly to having LPL services pitched at them, much less taking a back seat if regional or national competitors — banks on the level of Compass, Synovus and Capital One — are induced to climb aboard.

Naturally, trust service providers who liked being bigger fish in a $10 billion pond will end up gravitating toward partners that give them a better fit, Schmitt says.

Joseph Mrak isn’t gearing up to actively hunt these trust companies because he says Folio Dynamix is already a much bigger pond — but he expects other vendors to start wooing Concord accounts.

“This opens up the market a little for vendors like Fortigent and GlobalBridge,” he says. “Maybe even for us too. Maybe we can pick up a bit of the business in the Concord space.”

The triumph of open architecture

We’ll have to wait for future LPL earnings reports to find out how much they paid for Concord.

In terms of size and strategic value, Mark Casady has compared the deal to the $27 million acquisition of National Retirement Partners last summer.

At the time, that deal — which valued NRP at 63% its annual revenue — was widely considered overly generous.

But it also got LPL a toehold in the potentially vast retirement plan services market, and getting a similar toehold in the trust business is what industry observers say probably attracted the brokerage firm to Concord now.

“We’ve seen a lot of guys try to go after the trust space because there’s literally trillions of dollars there,” says Joseph Mrak.

“But it’s important that you know these markets, and they are not easy markets to get into. When you sell to independent advisors, you’re looking at more retail-style reps with a totally different customer base. Those guys are not trust officers.”

As those trust officers embrace open architecture solutions like those Concord and its rivals provide, the race for those trillion-dollar markets may only be heating up.

Two weeks ago, most of the brokerage trade publications didn’t even know what overlay investment management was, beyond some vague sense that it involved “open architecture.”

Today, this approach to wealth management is making headlines, and as bigger and bigger banks sign up, it will likely only get richer from here.

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

Permalink: http://thetrustadvisor.com/news/concord

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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More independent trust companies than ever are relying on overlay management software to streamline their investment process. However, finding the right fit can be difficult if you don’t know exactly what you’re looking for.

“Self-described overlay vendors run the gamut,” says Robert Testa, an analyst at Cerulli Associates who covers the wealth management industry. “Some simply provide access to third-party investment models. Some provide a more comprehensive technology solution.”

At its most basic, an “overlay” is simply a model used to determine how a given account should be invested. In traditional separately managed account (SMA) structures, the money is actually delegated to multiple outside managers to invest, but in an overlay system, the assets—and the ultimate responsibility—stay together in a unified managed account (UMA).

The UMA approach made sense for trust companies like Alaska Trust, which bought an overlay system from Matawan, NJ-based Concord Wealth Management about a year and a half ago.

“We really felt that investment management had become a utility just like the electricity at your house,” says Matthew Blattmachr, who runs the Alaska Trust system. “But we didn’t want to outsource the actual management. We wanted to make sure those assets stayed in-house.”

Flexibility, customization

It took Alaska Trust about a year to pick an overlay vendor once they decided to make the change. After auditioning several platforms, they chose Concord because it offered the best combination of flexibility and a-la-carte pricing.

“We just wanted the overlay,” Blattmachr says. “Our backoffice already provides some of the other capabilities that go into an UMA solution. And we wanted to make sure we weren’t going to get a cookie-cutter solution.”

Cost was another factor. A Concord system starts at around $50,000, which can be relatively inexpensive depending on the number and complexity of the investment accounts  a would-be customer is working with.

Robert Testa says that while other trust providers use similar criteria to find the best match, their motivations are often different.

“The bank trust departments in particular are looking to move away from proprietary asset management in order to streamline their operations and costs,” he says. “And some want to move away from the old stodgy image by offering more esoteric products.”

Developments in the larger accounting and compliance environment are giving some trust companies—banks and independent operators alike—a new incentive to consider switching to an overlay approach.

Trust officers looking for a way to break out investment fees from other expenses in the wake of Knight vs. Commissioner may need to change their accounting systems anyway, Testa says. “This presents them with an opportunity to offer UMA-style vehicles as part of the normal upgrade cycle,” he says.

A lower-cost solution

Depending on the exact solution a trust company picks, the long-term savings can be profound.

Just moving from a traditional SMA approach will provide access to the same institutional-level investment options at a lower price—not to mention cutting down on the amount of time and money it takes to manage the managers.

Many overlay systems also contain built-in due diligence and reporting functions that lighten the administrative load of coordinating with the underlying money managers. That’s especially attractive for a fiduciary institution that needs to ensure compliance with a trust account’s investment policy statement, but might not have the internal resources to keep one eye on the portfolio at all times.

In fact, there are overlay systems out there that let trust companies cut their fiduciary compliance costs by 75%.

“You can reorganize your staff,” Testa observes. “Bringing in a third-party solution relieves trust officers of the responsibility of being pseudo-portfolio managers and lets them go back to being full-time relationship managers.”

Finding a way to outsource the models while keeping the assets in-house was important for Alaska Trust for both fiduciary and client service reasons, Matthew Blattmachr says.

“A trust company can have a difficult enough time convincing clients to give us control of their assets without telling them that those assets would be managed by someone else,” he explains. “We didn’t think a lot of people would be receptive to that.”

Best of both worlds

To put this story together, the Trust Advisor team talked to a lot of other great overlay companies—the chart above lists a few of the top players out there—and each has its strong points. With about 70 clients, Concord is not the biggest shop out there, but it won points for giving independent trust companies like Alaska Trust a “best of both worlds” solution.

Most overlay vendors focus on either the RIA market or on the big banks. RIA specialists tend to provide more comprehensive systems that completely outsource the investment management piece, while those that mostly work with big banks often end up selling just the models and not the software that an independent trust company needs.

Trust companies often fall in the gap between the two models, says Roy Wheeler, who heads up business development at Concord. While they generally prefer to hire and fire their own third-party managers (like a bank), they often need technological support to make the process more efficient.

“On the trust side, they want the overlay, but they need to be the overlay manager,” he explains. “That’s where an overlay system can add value.”

Either way, business is booming. All the overlay providers we talked to say their client pipelines are packed with banks and trust companies, and some are looking at 75% to 100% growth over the next year.

It isn’t hard to see why. UMAs have been working their way through the RIA world for a few years now, and should represent a $327 billion market by 2013 according to data from industry research firm Celent.

Banks and independent trust companies have been relatively slow to catch on, but they’re moving in with a vengeance, Robert Testa says.

“Some of the vendors are very busy right now,” he explains. “Even trust providers often complain that they can move at a glacial pace, but this is where the industry gets going on the overlay front. This really is the way of the future.”

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

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