Managed accounts are another alternative to mutual funds that is becoming increasingly popular. Managed accounts involve more of a personal touch for the investor and more of a chance to tailor the portfolio to the client's needs. Managed accounts are also referred to as separate account management and separately managed accounts.

Investors with large account balances, measured in millions of dollars, have always had access to the personalized services of portfolio managers. Until very recently, investors with several hundred thousand dollars of assets were left out when it came to any kind of personalized management. The general belief was that the only real choice was mutual funds if you wanted both diversification and professional management but had less than, say, $1 million in assets. This is no longer true.

What is a separate account exactly? A separate account can be defined as a privately managed investment account that is opened with brokerage firms or through financial advisors. The client gains access to private asset management firms, using the advisor to manage the portfolio. One wrap fee, based on an asset-based fee structure, pays all of the costs of the account. An asset-based fee structure means that the fee the investor pays is based on the assets he or she has under management in the separate account.

When you see the words "separate account" or "managed account," think of an account for investors offering customized portfolios and tax efficiency. Separately managed accounts are often promoted as a way to invest for the long term that can keep portfolios properly balanced, give investors the right to make some specific decisions regarding portfolio holdings, and be efficient with regard to taxes. Perhaps for some, they have "snob appeal" because the owner can say "I have a separately managed account where the minimum to open one is X dollars." Contrast that to mutual funds, where the minimum needed to get started is often $2,000 to $3,000. Although mutual funds are available to the masses, separately managed accounts have large initial investments and are not available to many investors.

An investor in separate accounts directly owns the securities. The portfolio is, in principle, specifically managed for his or her benefit. In the case of financial advisors, in particular, the advisor could help the investor determine an appropriate asset allocation plan. Then, the advisor or broker can determine one or more money managers to carry out the plan.

In practice, the typical managed account begins with a ready-made portfolio based on some investment style, such as large-cap value stocks, small-cap growth stocks, and so forth. Such portfolios can be offered to many different investors with separate accounts. The investor then has the chance to modify the base portfolio to meet his or her specific needs.

One of the benefits of the managed account is the closer integration of the account with the client's overall investment approach. For example, if you own a significant number of shares of your employer's company, the managed account can be structured to avoid this company. With a mutual fund, you might be buying an additional position in the company because you must buy into the mutual fund's entire portfolio. The managed account offers the investor much more of a change to tailor a portfolio, avoiding companies that are unattractive to the investor.

What is the cost of a managed account? The starting fee as quoted is typically three percent of account assets per year. However, this is a negotiated fee, and it varies depending on the firm managing the account and how much is involved in the account.

The typical client now is paying slightly less than two percent for this service (the fee includes trading costs) on accounts worth less than $1 million. This is higher than the average equity mutual fund operating expense ratio, which is 1.42 percent of assets, but not inordinately so.

Brokerage firms provide personalized portfolios for clients. In fact, most separately managed accounts to date have originated through financial advisors affiliated with brokerage firms.

As of mid-2001, Salomon Smith Barney had about one quarter of the market share among large brokerage firms, followed by Merrill Lynch with more than 20 percent. Other brokerage firms such as Morgan Stanley Dean Witter, Paine Webber, and Prudential had smaller percentages. These five firms together held about 70 percent of the total assets in separately managed accounts in 2001.

Charles Schwab, the giant discount broker, offers a program called Managed Account Select. Financial advisers can choose among 25 different managers for their clients, and these managers represent eight different investment styles. An account can be opened with as little as $100,000. The total cost of this package, the wrap fee, is 1.75 percent of assets, and that includes the financial adviser's fee. Compare this to the average expense ratio for equity mutual funds of about 1.42 percent, and it is easy to see that this is now a very viable alternative.

Of course, if a client has several million dollars in such an account, he or she probably can speak with the manager. Here again, nothing has changed. Wealthy investors—or those called in the business high net worth investors—have always had direct access to their money managers.

Although still small by mutual fund standards, the assets in managed accounts have been growing rapidly.

As you can see, growth was rapid through 2000, and then leveled off for 2001, probably because of the general market decline. The total amount of assets under management still pales by comparison with the nearly $7 trillion in assets for mutual funds, but the growth rate indicates increasing interest on the part of investors. For example, assets grew 80 percent from 1996 through 1998, and then grew another 44 percent by 2000.

Interestingly, while mutual fund assets declined by approximately eight percent in 2001, separate account assets declined less than 0.5 percent. All of these numbers suggest that the separate account is a rapidly emerging alternative to mutual funds that will become increasingly popular in the future.

Such growth would be expected to attract new competitors, and sure enough, it has. Fund companies are becoming interested in this market, and some have already started offering products in this arena. Fidelity, the largest fund company, has starting offering separately managed bond portfolios.

To date, it appears that despite the higher fees charged, the mutual fund business is more profitable than the managed account business because it is considerably more expensive to provide the personalized services involved here. Thus, we can expect the mutual funds to continue to battle for investors' funds, and for the game to continue.

It is also true that in some ways mutual funds have an edge. For example, mutual fund results are reported by the two major independent services, Morningstar and Lipper. With separate accounts, there may be no uniform reporting because of the many different scattered managers. However, as the industry continues to grow, it is reasonable to assume that Morningstar, Lipper, or someone else will provide some uniform reporting statistics.