2010 Glossary of Terms
Index of Terms Alternatives...4 Asset Manager Addressable Marketplace (AMAM)...4 Cerulli Scalable Advice Continuum...4 Guidance Mass Customized Guidance Modular Advice Ongoing Advice Financial Planning Holistic Service CIO outsourcing...5 Distribution...5 Institutional/Retail Direct Institutional/Retail Affiliated Institutional/Retail Third-party Embedded Advice...5 Financial Advisor...5 Financial Advisor Practice Types...5 Money manager Investment planner Financial planner Wealth manager Glidepath...5 Institutional Asset Management...6 Intermediary Channels...6 Wirehouses Bank brokerages Independent broker/dealers (IBD) Regional broker/dealers Insurance broker/dealers Registered investment advisors (RIA) Liability-driven Investing...7 Managed Accounts...7 Managed Account Components...7, 8 Client Profiling Asset Allocation Ongoing Monitoring Consolidated Statements Identifiable Fee Asset-Based Fee Managed Account Programs...8, 9 Mutual fund advisory programs Packaged programs Hybrid programs Open programs ETF advisory programs Rep-as-advisor programs Rep-as-portfolio-manager (RPM) programs Separate account consultant programs Subadvisory programs Open programs Unified managed account (UMA) programs Model portfolios...9 Multiaffiliate...9 Overlay management...9 Platform...10 Portfolio Construction...10 2 2010 Cerulli Glossary of Terms
Index of Terms (continued) Professional Buyer...10 Retail Asset Management...10 Retirement Income Products...10 Subadvisory...10, 11 Affiliated Unaffiliated U.S. Retirement Marketplace...11 Wealth Tiers...11 Ultra-high-wealth market High-wealth market Wealth market Affluent market Mass-affluent market Middle market Mass market 2010 Cerulli Glossary of Terms 3
Alternatives Cerulli considers retail alternatives to be any product that pursues an alternative strategy or invests largely in an alternative asset class. This includes hedge funds, active extension (e.g., 130/30), absolute return, alternative/green energy, bear market, commodities, arbitrage strategies, currency, derivatives, forward contracts, global tactical asset allocation, infrastructure, inverse, leverage, managed futures, market neutral, merger/risk arbitrage, portable alpha, private equity, private real estate, and venture capital. We do not consider vehicles such as exchange-traded funds (ETFs) or structured products to be alternative investments unless they pursue an alternative strategy or asset class. Asset Manager Addressable Marketplace (AMAM) Cerulli created the asset manager addressable marketplace (AMAM) distribution model to more accurately present the true opportunity for U.S. asset managers. Overlayed on total U.S. assets under management, AMAM removes non-professionally managed assets and adjusts for double-counted assets, thus presenting the cleanest view of the aggregate size of the asset management industry in the United States. Cerulli s Asset Manager Addressable Marketplace Distribution Model To size the true opportunity available in the professional asset management marketplace, Cerulli created the Asset Manager Addressable Marketplace (AMAM) distribution model (AMAM), which removes non-professionally managed assets and adjusts for double-counted assets. Cerulli Scalable Advice Continuum Guidance The practice of offering general information on widely accepted best practices in personal finance. Without any level of customization, providers need to cast a broad net here. Examples include suggestions to save more, spend less, and general asset allocation information. MassCustomizedGuidance As the name implies, this level of guidance adds a bit of variability in information delivered, but is still not individually customized. The most typical example at this level is the asset allocation questionnaire through which, after completing, investors receive a general, broad, asset allocation suggestion. The results are often limited to a small solution set and are static in nature. ModularAdvice This level of advice sees the addition of some art to pure calculation. A reasonable level of information about the investor is collected, resulting in the provision of one or more solutions. The investor s feedback is then used to tweak the results to include preferences and provide recommendations that are specific to the investor s circumstances. Examples of modular advice include stand-alone retirement or college-funding calculators that are either delivered online or during one-on-one consultations. OngoingAdvice Here we see the addition of a relationship aspect to the advice-delivery process. In addition to running initial calculations, an advisor will monitor the investor s progress towards their financial goals and proactively contact the investor on a regular basis. This level represents a large share of current advisory relationships, reflecting a delicate balance of investor expectations and an advisor s time commitment to each investor. The advisor has an understanding of the investor s financial position and expectations but is generally most focused on the investment management (and possibly insurance) part of the equation. FinancialPlanning This level sees the expansion of the investor relationship beyond investment management to encompass the six-step process as outlined by the CFP Board of Standards, whether or not it is delivered by a CFP accredited advisor. Though the engagement could be limited by agreement of the investor and advisor, these relationships are most often ongoing and comprehensive in nature with the exact scope of the engagement defined in a written agreement. HolisticService The final echelon of advice incorporates all the elements of financial planning and expands beyond the milieu of services typically offered in a financial planning setting to include lifestyle issues. Examples of these additional areas include life planning or coaching, teaching heirs about finance, or concierge-type services. 4 2010 Cerulli Glossary of Terms
CIO outsourcing CIO outsourcing refers to a specific level of engagement whereby the authority to change asset allocation, select, and replace investment managers is largely delegated to an investment consultant. Instead of simply making recommendations which the sponsor might need to digest slowly and vet by committee, CIO outsourcing allows corporate officers to focus on their operating business, and outsource plan oversight to a third-party expert. In some cases, these decisions are outsourced to an asset manager, rather than an investment consultant, and may also be referred to as fiduciary management, master manager, or strategic partnership. Distribution When referring to distribution, Cerulli has identified six models: retail direct, retail affiliated, retail third-party, institutional direct, institutional affiliated, and institutional third-party. Institutional/RetailDirect Arrangements in which asset managers gather assets from institutional or retail clients via direct relationships. Importantly, the sales process is conducted using only proprietary resources and personnel and excludes arrangements involving any unaffiliated third-party, or platform. Institutional/RetailAffiliated Arrangements in which asset managers gather assets from institutional or retail clients via affiliated or captive third-parties, such as via proprietary broker/dealers or private client groups. Institutional/RetailThird-party Arrangements in which asset managers gather assets from institutional or retail clients via unaffiliated third-parties or platforms. Embedded Advice Funds as products that package an advice component within a mutual fund, or fund-of-funds, structure. The advice that is embedded into the product adds a layer of asset allocation, and diversification, to the portfolio. We count balanced funds, asset allocation funds, and lifestyle (risk-based) and lifecycle (target date) funds as embedded advice products. Financial Advisor One whose practice has two key elements: the advisor must be primarily serving retail investors and the advisor s objective must be to manage all of their clients money. Investors might maintain multiple financial advisor relationships, but the advisor must be seeking to be the primary financial advice provider for their clients. Financial Advisor Practice Types Moneymanager Advisors who build portfolios of individual securities and mutual funds for clients and focus exclusively on asset management. Investmentplanner Typically advisors that emphasize asset management as their primary service, but may offer modular planning services such as retirement planning or education funding. Financialplanner Advisor who develops complete financial plans for clients based on an extensive analysis of their assets and liabilities. Wealthmanager Specialize in comprehensive wealth management and transfer issues, including stock option planning, executive compensation, complex trust and estate planning, and charitable giving. More Planning Less Planning Glidepath Cerulli defines glidepath as the gradual reduction of risk within a portfolio, achieved by adjusting the allocation of assets to more conservative investments. It reflects long-term expectations of risk, return, and correlations. It is typically used when referring to target-date mutual fund strategies. 2010 Cerulli Glossary of Terms 5
Institutional Asset Management Cerulli considers institutional asset management to consist of investment management in six segments of the financial services industry: defined benefit, defined contribution, endowments, foundations, insurance general accounts, and subadvisory. Intermediary Channels Channel Distribution Organization/Capabilities Advisor Profile Wirehouses -Large national advisor and branch advisor networks -Have large investment banking and institutional presence -Strong metropolitan presence -Employees of the B/D -Recruit experienced reps and train new entrants -Offer a full range of investment services and products -Place emphasis on fee-based pricing through managed accounts Bank brokerages Independent broker/dealers (IBD) Regional broker/dealers Insurance broker/dealers Registered investment advisors (RIA) - Generally regionally focused -Vary in size from national banks to credit unions -Mix of organically grown brokerages and regional B/D acquisitions -Small banks, thrifts, and credit unions often leverage third-party marketing firms -Largest channel in terms of reps -National distribution capabilities, but fragmented advisor coverage and small branches of one to five advisors -More than 1,100 firms with the top 20 representing the bulk of advisors -Target of acquisitions by insurers and banks during the past decade -Channel includes regional investment banks with retail branches, firms with national salesforces, and private wealth arms of NY-based investment banks -Range from five-person shops to 1,000+ reps and often have strong regional and community ties -Most large regionals have been acquired by banks or wirehouses -Varied institutional and investment banking services depending on firm -Little or no proprietary products -National distribution capabilities through historical career agency network -Firms range from traditional life companies to quasi-ibds -Strong proprietary insurance and investment products, but often use third-party subadvisors -Includes firms with both open and closed insurance product selections, however, nonproprietary asset management is always available -National distribution capabilities, but fragmented advisor coverage -Leverage clearing firms, banks, service agents, and brokerages to conduct trading, recordkeeping, and custody -RIAs are fee-based and emphasize financial planning and wealth management -Retail-oriented, branch-based operations that employ dedicated and part-time advisors or platform reps -Heavy emphasis on packaged products, mutual funds, and annuities -Struggle with servicing core demand deposit account (DDA) clients while trying to pursue more affluent investors -Independent contractors rather than employees -Advisors assume most of the cost of running their practice -Target experienced reps from other B/Ds and insurance companies -Heavy emphasis on packaged products, mutual funds, and annuities -Employees of the B/D -Primarily recruit experienced advisors -Offer a full range of investment services -Insurance agents being repositioned as advisors -Many traditional insurance B/Ds have shifted to an IBD model -Range from employees/career agents of the B/D to statutory employees to independent contractors -Heavy emphasis on insurance products -Small practices (<20 advisors) -Some are also affiliated with a B/D and are FINRA licensed (dually registered) -Primarily focus on the affluent market -Advisor backgrounds include financial services as well as unrelated fields 6 2010 Cerulli Glossary of Terms
Liability-driven Investing Broadly defined, Cerulli uses the term liability-driven investing (LDI) to describe defined benefit plan sponsors identifying plan liabilities as the most appropriate funding strategy. LDI strategies need not specifically immunize the plan 100% from interest rate risk, but should at least recognize that traditional plan benchmarks (e.g., 60% S&P 500/40% Barclays Aggregate) are but arbitrary hurdles; an asset allocation driven by expected plan liabilities will be better grounded for funding requirements in the law. Managed Accounts Managed accounts is the umbrella term used in Cerulli Associates' research to describe all fee-based advisory programs at broker/dealer firms. Within these programs, investors receive a wrapped set of services, including client profiling, asset allocation, money management, trading, custody, clearing and performance reporting. Managed account platforms implement fee-based advisory business through broker/dealers. A goal of Cerulli's coverage of the managed account industry is to illuminate how clients are being serviced through broker/dealers in a fee-based arrangement, as opposed to commission or transaction-based models. Therefore, we do not include trust business and private accounts run for high-net-worth clients in our research and analysis as the addition of these services would suggest inclusion of a much larger pool of assets. In order to accurately size the broker-sold managed account industry, a consistent standard must be applied to assets which Cerulli tracks. Below are some of the common characteristics for identifying and determining the inclusion of a managed account program in our marketsizing. Program services are distributed through a broker/dealer Program assets are held in an advisory (regulated by the SEC) arrangement Advisors providing services to clients in the program are FINRA registered, or are independent RIAs using a platform provided by a third party (e.g., Charles Schwab, Fidelity) Clients are provided with Schedule H of Form ADV Advisor receives asset-based fee for advice Program has a name and is marketed as such Managed Account Components Each of the six segments of the larger managed account industry, while comprising different products or delivered in different formats, all contain the following six key attributes. Collectively, these attributes make managed accounts a distinct and systematic investment product. Although it is arguable that some of Cerulli's segments of managed accounts do not adhere strictly to all of the following, Cerulli is confident that the spirit of all of these attributes is found in the programs we have identified. Moreover, with the onset of unified managed account (UMA) platforms, the industry stands poised to deliver product-neutral managed account services truly based in these tenets. The six attributes are: ClientProfiling The managed account process begins with client profiling, with financial consultants working with clients to develop a deep understanding of their assets, liabilities, risk tolerance, and goals. Once an investor profile has been developed, a proposal is generated that includes either recommended portfolios or individual asset managers, depending upon the type of program, to help achieve certain goals within certain risk parameters. AssetAllocation The managed account program must be based on a viable asset allocation model. Studies show that asset allocation is the single greatest factor impacting portfolio performance, and the incorporation of modern portfolio theory is a key advantage of managed accounts. Asset allocation shows up most strongly in the mutual fund advisory arrangement, wherein a client might be assigned to one of 12 different models with each one containing six to eight funds. In separate account programs, reps are encouraged, but often not required, to allocate among managers. OngoingMonitoring Typically, this means a face-to-face visit twice per year, or as needed, in addition to quarterly communications. As part of the monitoring process, refinements are made to the portfolios, often quarterly (or when appropriate), to reflect current market conditions or changes in specific client goals. 2010 Cerulli Glossary of Terms 7
(Managed Account Components continued) ConsolidatedStatements Managed account programs must also provide consolidated statements, detailing all account activity, including a client's relationships with multiple money managers as well as individual security positions managed by each one. Separate trade confirmations are generated for buy-and-sell activity across an investor's portfolio. Customized and tailored reports are produced for clients, illustrating the value of their investments. IdentifiableFee The fee paid by the client must be discrete and identifiable. Breaking out the fee is important to the future of the rep-client relationship, as it is an institutionalized way to keep the rep engaged in providing ongoing personalized attention. The unbundled advisory fee is particularly evident in mutual-fund-based programs in which the advisory fee is broken out from the underlying blended mix of mutual funds. Asset-BasedFee Managed account clients are also charged an asset-based fee for the range of services provided above, including trading, custody, and ongoing advice. This fee is charged to the client's account and paid on a quarterly basis, typically in arrears. Commissions are not charged in subadvisory separate account programs, though in open separate account programs in which clients have an additional contract directly with the asset manager, clients may also elect to pay some form of directed brokerage commissions or fee plus ticket charges. Managed Account Programs Mutualfundadvisoryprograms Discretionary and nondiscretionary programs designed to systematically allocate investors' assets across mutual funds. Services include client profiling, account monitoring, and portfolio rebalancing. An asset-based fee of 1.25%, for example, is charged instead of commission. There are three types of mutual fund advisory programs, differentiated by an advisor's ability to influence final portfolio construction: packaged, hybrid, and open. Packaged programs Representing the earliest versions of fund advisory programs, packaged offerings remit investment decision-making responsibilities to central research committees. Advisors select from packaged investment models for clients based on individual risk-and-return profiles. Hybrid programs Offering more choice and flexibility than packaged programs, hybrid offerings allow advisors to populate centrally provided asset allocation models with funds typically from a select list. Adjustments may also be made to the allocation models themselves to meet individual client needs. Open programs As the name suggests, these programs offer advisors a great degree of flexibility in building fee-based mutual fund portfolios for clients. From a client profile, an advisor typically has broad discretion to customize an asset allocation for each client. These programs are most typically found among independent broker/dealers. ETFadvisoryprograms Discretionary and nondiscretionary programs designed to systematically allocate investors assets across various ETFs. Services include client profiling, account monitoring, and portfolio rebalancing. An asset-based fee is charged instead of commission. There are three types of ETF advisory programs, differentiated by an advisor's ability to influence final portfolio construction: packaged, hybrid, and open (see packaging explanation under Mutual Fund Advisory program definition). Rep-as-advisorprograms Fee-based nondiscretionary advisory accounts in which the advisor must obtain approval each time a change is made to the account or its investments. However, as with rep-as-portfolio-manager programs, advice is an essential element of this type of program, and advisors and firms must be registered with both the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC). These programs typically use individual securities and mutual funds. Rep-as-portfolio-manager(RPM)programs Fee-based discretionary advisory programs in which financial advisors act as money managers for their clients by taking full responsibility for selecting portfolios of securities. The advisor has discretion over these fee-based 8 2010 Cerulli Glossary of Terms
(Managed Account Programs continued) accounts (either an asset-based fee or alternative fee structure). Advisors must go through training or meet criteria to qualify for participation in the program. There is often both a senior- and junior-level version of the program, differentiated by how much flexibility is given to the advisor in building portfolios. Advisors who oversee these accounts (and their firms) must be registered with both FINRA and the SEC. Separateaccountconsultantprograms Programs in which asset managers administer portfolios of individual securities for investors in discretionary separate accounts. Account minimums are typically $100,000 to $250,000, and may be higher. A bundled assetbased fee (often 2.5% to 3% before breakpoints and discounts from negotiation) covers money management, trading, and custody. There are two classifications of separate account programs; subadvisory programs and open programs. Subadvisory programs Single-contract arrangements in which a sanctioned roster of asset managers is offered on the platform and in which sponsors determine account minimums and management fees. Open programs The open category consists of both dual-contract programs and proprietary programs (both of which are systematically unaddressable by third-party asset managers). Dual-contract programs In dual-contract programs, there are a virtually unlimited number of managers available on the platform, and asset managers maintain an additional contract directly with the investor. Proprietary programs Proprietary programs are those closed architecture offerings where an asset manager affiliated with the sponsor provides asset management for the client. Asset management for these platforms should be conducted through a platform similar to subadvisory programs portfolios should track to a model (often delivered through APL). Unifiedmanagedaccount(UMA)programs Discretionary and nondiscretionary fee-based programs for which multiple investment vehicles (e.g., separate accounts via model portfolios, mutual funds, ETFs, and rep-selected individual securities) are used to build client portfolios in a single environment. A UMA may consist of multiple managed account programs feeding into a single UMA process. Overlay management is a necessary feature of UMA programs. UMA platforms suggest the capability for program sponsors to take a very holistic look at an investor's holdings, and service clients with a range of solutions to combine a broad asset allocation plan along with elements of an asset allocation (taxable vs. nontaxable account) strategy. Model portfolios Situations in which asset managers are hired as research providers and periodically submit portfolio holdings information to a program sponsor or overlay manager. Multiaffiliate Cerulli defines multiaffiliate (a.k.a. multiboutique) asset managers as firms that assemble products managed solely or largely by affiliated asset managers, delegating the majority of security selection and analysis to self-governing. In contrast, we define managers of managers as those who work largely or solely with unaffiliated subadvisors. (for more information on affiliated and unaffiliated managers see subadvisory ). Overlay management The goal of overlay management is to simplify, centralize, and systematize a process that has been occurring throughout the fee-based industry for years. In its most basic form, overlay management facilitates the acceptance of model portfolios and the execution based on that model for client accounts. Originally, the benefit of overlay was to systematically realize the tax-management features of separate accounts (e.g., tax-loss harvesting on an ongoing basis and client restrictions). The overlay process sits between the intellectual capital of the asset manager (i.e., the model portfolio) and the client account, which allows client-specific information (e.g., tax budgets and other investment positions) to augment how the model portfolio is applied to the client account. 2010 Cerulli Glossary of Terms 9
Platform A set of financial services products with a distinct pricing and accounting structure, often bundled as a turnkey record keeping and administrative system for customer (and more often intermediary) use. There are two types of platforms: external and internal. Portfolio Construction Portfolio construction is the approach by which investment portfolios are assembled and managed. Cerulli views portfolio construction as more holistic and investor-outcome focused than portfolio management, which we view as less encompassing and principally investment-centric. Examples of approaches to portfolio construction include nine-style- box diversification and core satellite investing. Professional Buyer Cerulli defines a professional buyer as any person or group using institutional-quality research to perform manager selection. Professional buyers include subadvisory sponsors, investment consultants, multimanagers, managed account sponsors, and other broker/dealers performing high-quality manager research. Retail Asset Management Cerulli considers retail asset management to consist of investment management firms that pool the assets of individual investors and invest them in vehicles with declared financial strategies and objectives (e.g., mutual funds, exchange-traded funds) providing investors with more diversification and professional management then they would be able to obtain on their own. Retirement Income Products Cerulli considers retirement income products to be those that offer income stability or target a specific return (e.g., target-date funds). These, mostly first-generation, outcome based solutions are built and marketed around their ability to produce a particular result by a pre-determined date. They are typically a hybrid product, combining insurance and mutual funds and often providing guarantees. There are many obstacles to the development of such products ranging from regulatory hurdles to finding economically feasible and reliable investment approaches, to financially engineering income or principal guarantees, and finding the appropriate price to charge for a guarantee. There are also numerous risks to consider inflation, longevity, market, behavioral, healthcare costs when developing retirement income solutions, contributing to the complexity of manufacturing such a product. Subadvisory The term subadvisory is used broadly to describe any portfolio management relationship in which more than one entity assumes responsibility for the various components of investment advisory (i.e., fiduciary, security selection, and trading). Cerulli s definition of subadvisory focuses on retail-based products: mutual funds and variable annuities (VAs), ETFs, and retail separate accounts. In short, an asset manager hired to subadvise retail-sold mutual funds or VAs for which the hiring firm serves as advisor is working in a subadvisory capacity. Our definition does not include what traditionally has been the foundation of institutional asset management managing pension fund assets because in the majority of these arrangements the asset manager is acting as advisor (e.g., fiduciary) for the pension fund; there is no subadvisor involved. In addition, the product (e.g., legal, compliance), the sales process, and the ongoing administration responsibilities often differ vastly than those of retail mutual funds. Affiliated Affiliated subadvisory relationships are those agreements in which there is a direct legal or financial relationship between the subadvisor and sponsor. Because of this ownership, the dynamics of the relationship differ vastly from an unaffiliated relationship. The profitability of such relationships more closely resembles those of an internally managed product than it does an unaffiliated subadvisor-managed product. 10 2010 Cerulli Glossary of Terms
(Subadvisory continued) Unaffiliated Strictly speaking, Cerulli defines subadvisory relationships as unaffiliated if there is no legal or financial relationship between the two entities. Cerulli believes that if the advisor or sponsor has even a minor financial stake in the subadvisor, the dynamics of the relationship influence decision making. As outlined in Cerulli research, there are a number of relationships that, on paper, represent unaffiliated associations, but upon further review are not. U.S. Retirement Marketplace Cerulli considers the U.S. retirement marketplace to consist of individual retirement accounts, retirement income products and services, public defined benefit (DB), private DB, public defined contribution (DC), and private DC. We consider the public DB marketplace to include federal, state and local government DB assets. Our public DC market sizing includes thrift savings plans, Taft-Hartley plans, 403(b) and 457 plans. In private DC, we include 401(k) plans, individual 401(k) plans, money purchase pension plans, profit sharing plans, and Keoghs. Wealth Tiers Ultra High Net Worth High Net Worth { { Name of Tier Investable Asset Range Net Worth Range Ultra-high-wealth market >$20m >$50m High-wealth market >$10m-$20m >$25m-$50m Wealth market >$5m-$10m >$10m-$25m Affluent market >$2m-$5m >$5m-$10m Mass-affluent market >$500K-$2m >$1m-$5m Middle market >$100K-$500K >$250K-$1m Mass market $100K $250K 2010 Cerulli Glossary of Terms 11