Podcasts Scaling to New Heights: The Growth of Managed Accounts with Mike Martel

Damian Cilmi: Welcome listeners to another episode of the Praemium Investment Leaders podcast. I'm your host, Damian Cilmi, Head of Investment Managers and Governance of Praemium, one of Australia's leading investment platforms. Today, we're really pleased to be joined once again by Mike Martel from State Street Global Advisors. We recorded with Mike back in 2019 and discussed trends in managed accounts in the United States. We're going back to revisit these trends and ask Mike what's the likely outcome to come to Australia for investors. About State Street. For those who don't know, they were founded back in 1792 and State Street is one of the oldest diversified financial institutions in America. The asset management division manages over $3.5 trillion in assets under management. And about our speaker Mike is Managing Director of State Street's Global Advisors and the head of Portfolio Management in the Americas for SSGA's Investment Solutions Group. In this role, he is responsible for the design and management of multi-asset class strategies geared towards meeting investment objectives of a broad and diverse client base. He's been working with the investment management field since 1992. Mike, welcome back to the show.

Mike Martel: Damian, thank you for having me. I really appreciate you being here, and thank you for pointing out my age. I appreciate that as well.

Damian Cilmi: That's all right, and you're back here from Boston.

Mike Martel: Yeah really happy to be here, especially at the state of the football team back in New England. I'm happy to be out of the country.

Damian Cilmi: Yes, fair enough, we were talking about the basketball earlier. So hopefully a good year for the Celtics this year, absolutely so up and up there. So let's go back to where we went in 2019. And we were really interested to do this podcast here because America has been at the vanguard of manages accounts and Australia follows a lot of those trends that ends up being implemented here. So we're really curious to hear your observations about what's going on there and we did that last time and I feel like we can refresh and what's happened over the last couple of years. And so for our listeners who may not be as familiar with the US market, kick us off by painting a picture of the current SMA landscape and how does it compare to what you see here in Australia?

Mike Martel: Yeah, happy to do that and maybe just to kick off just State Street's role within this landscape. So what you'll hear me talk about a lot would be third-party asset managers and the role they play within managed accounts and State Street being one of them. The role that we play specifically here is as a model portfolio provider. So in the US, if you look at the size of the model portfolio business right now, it's massive. It's $2.2 trillion and while that's a really big number, I always try to get my head wrapped around that from a comparison purpose. And if you looked at the US, I think it's 12 to 13 times the size of the Australian market, maybe roughly the size of the superannuation industry here, pretty much right in that neighbourhood. The truly amazing thing is that the expectations for growth are dynamic. So the expectation is that this industry will reach $10 trillion over the next few years, and the reason being there's at least $7 to $8 trillion sitting in advisor practices who are just not well equipped to really implementing model portfolios and bringing that scale into the business. So when you start talking about assets of that size, it's no shock that asset managers are very excited about this opportunity. So right now, asset managers as a whole, probably around 350 to 400 billion of that large AUM. But our growth is expected to hit something like $3 trillion and that's being driven by really, really strong annualized growth rates that are being projected for that segment. Really, there's two dynamics here. You've got decentralized model portfolios I think your home offices, but also think about third-party asset managers growing very dynamically. But the advisor-driven model portfolios really starting to tail off and what's driving that is home offices are really really keen to scale the business, and the way they scale the business is you bring in the model portfolios so that you can, number one, cut down on the regulatory burden, so compliance costs go down. But two, you're refocusing your FAs so your financial advisors can focus on improving the client experience. You improve the client experience, you increase your wallet share. The other thing that you can do is you have more time to just grow the business in general. So certainly huge trends that are really pointing to great growth in this segment. Now, if you think about who the big players are in the US, there's three big categories that we'll look at. So it's registered investment advisors, so smaller firms think about investment advice, financial planning. Then you've got the independent wealth managers a little bit bigger. They tend to be aligned with the platform and get some back office support. And then you've got the private wealth managers that are basically your wirehouses. So the big name brands so you think Morgan Stanley, Merrill Lynch, growth across all segments is what we're seeing and if you think about where investors are going, it's really the traditional risk-based models are like 89% of the usage, which is kind of interesting. It's the bread and butter of investing, really focused on really strong asset allocation. And if you look at it through the lens of strategic versus active, now 78% of the usage is in strategic, not active. So again, hopefully not too long-winded there, but just a lot of exciting things around the US side.

Damian Cilmi: No, that's it. We see, I think, a lot of commonality out of that from a domestic market here and also the different client segments. In our experience they're using it all very, very differently, but they're all participating and there's no doubt that those growth numbers will be something that we see here as well too, and interesting to see that it's not slowing down. But you said there was probably a little bit of slower growth in the RIA market.

Mike Martel : More the slower growth is more in. So advisor directed and really the idea is scale. So the whole like is what we say in the US rep is PM. That whole concept is being de- emphasized in favor of something that's much more scalable. So when you look at the growth rates, the growth rates are much higher and more centralized. The portfolio is, I think, more in the advisor directed Interesting.

Damian Cilmi: Now drilling down into, I suppose, what's happening at the portfolio level, because you gave us a great background to the users at the portfolio level. Let's get right into it. Active versus passive I suppose we've seen a big usage of passive strategies, which you know, in fairness, was a right move for a long period of time. Are we starting to see that change now?

Mike Martel: Well, what we're seeing is that investors and this is, let me just back up, this is a trend that we've started seeing on the institutional side first, and then very, very quickly adopted on the retail side.

Damian Cilmi: It happens here too. Yeah, absolutely.

Mike Martel: And really what it is is investors are picking their spots much better in terms of where they want to utilize their active risk budget and really what's driving it is they're looking to play in those spaces where the game is more in their favor, so less efficient asset classes. Also, the other concept that's been really, really powerful is the idea of really maximizing value for fee, and so, depending upon who you are, you might maximize value for fee by being at something that's all passive, really low cost, but somebody else might get more utility out of, Hey, I've got a great active strategy and maybe I want 30% of my portfolio inactive because I'm going to really derive a lot of value from that. So that's where a lot of this has come being more fear, aware, being smarter about where you're taking your active risk and that's really been implemented in these core satellite approaches. If you think about the model portfolio business and the statistic I threw up earlier about having that core of risk-based strategic, if you're locking up 78% of your portfolio and that gives you 22% of your assets, to really be more selective and is it the best alpha manager you can find in a space? Is it something else? Maybe it's an alt, whether it's liquid or illiquid, and it's really about building the most efficient portfolio that you can. The other one that's kind of interesting I'd love to talk a little bit about, especially in the model portfolio space, is how we're building them, so a couple of ways that it's happening. Number one you could get a provider who will go fully open architecture for you. Now, when I say fully, there's always the AUM requirements and things like that, because, as a commercial layer. Yeah, there's that commercial side, and nobody wants to pay an overlay fee, yeah Right. So that's one aspect of it. But the other aspect that I find really interesting is what we're calling partnership models. So the idea here is you get two asset managers that have got complementary strategies that come together and build a really compelling investment offering, but then the other side of it is both of those managers commit resources on the distribution side. This is very interesting.

Damian Cilmi: Yeah, have you done a few of things we have? Yeah.

Mike Martel: We're resonating well with the big wire houses, yeah, and what's interesting for us is that it's definitely a two-way kind of street, meaning that we're being approached by active managers at the same time that we're approaching active managers, so it's been kind of a fun evolution.

Damian Cilmi: So I want to touch on that one there. Just on picket probably two-part question here. Going back to the combining of passive and active, I'm keen to hear your thoughts about where active is being used in aggregate. When you have a look across your consulting portfolios, where are you using active the most? And then my follow-up question is when you've done these partnership ones, how have they kind of looked? Well, what's the kind of the combination of active strategies that you've used?

Mike Martel: Yeah, I would say most common. The starting point for us is we'll do work internally with our manager research team and they'll help us find which asset class is really in general. Do you have? The median manager tends to outperform or off. And then, no surprise, it's things like smaller stocks, emerging markets, core bonds, and that's always the interesting one to me. So if you think about the US marketplace, the US aggregate bond index is one of the most widely used, but it's also the one that's most widely targeted by active managers because they tend to have an easier time outperforming there. So those are usually where we see a lot of the active. But when you think about the partnership angle to this, the interesting piece of that comes from. Again, there's the two sides. There's the compelling investment thesis, but then there's also the distribution support there. So you do need to find the right partner, and when you're limiting yourself to one partner, the fun part comes in. Okay, well, which strategy of yours is most compelling versus what we're offering?

And then you get down to the nitty gritty about okay, what level of AUM are you looking for, what level of revenue? And you need to make sure that it is a partnership, because you want everybody to be committed to its success. So you've got to make everybody as happy as you can.

Damian Cilmi: Everyone thinks their own grandmother's cooking's the best. Absolutely, absolutely. Yeah, that would be interesting. Another thing that we've started to see a little bit here and I'm keen to hear your thoughts in the States is around personalization trends. So and this is kind of that weird one, because you're trying to play for scale, but now we're talking about customization so how do we get that mass customization? Are you seeing it happening over there and what are those kind of trends?

Mike Martel: Yeah, you just. I mean, that's spot on. I mean, technology is really starting to enable personalization and you know, let me just back up and just say that there's a lot of words that get thrown at this topic personalization, customization, custom models. I'll start with my view on personalization, if that's all right. I view that as being driven by the end client. And so, going back to the US, if you think about the wealth industry and how it's evolved, back in the 70s and 80s, the big event was corporations deciding to shut down pensions, and so you had this big surge of interest into the wealth industry. And what was everyone looking for? Accumulation. You had to start growing your nest egg in order to be able to retire. Well, you fast forward to today and your youngest baby boomers are in their 60s. So now what are you looking for? Now you've got accumulation. Now you've got just as many people looking for income. Introduce younger investors into the mix. Younger investors have got demands beyond accumulation and income, and some of them are non-financial. We all ESG thematics like innovation, playing different energy transition and things like that, and so when you're the FA and you're being beseeched by these different requests, it's very becoming harder and harder to assign cohorts, and so really that's part of the trend is to say, okay, what is driving client demand that FAs are facing? How it gets translated back to model portfolio space happens in a few ways, so one would be moving to custom model portfolios. So custom model portfolios tend to be built by asset managers, and generally what you have is deviations from the off the shelf offering that align better with that specific client segment, and it's kind of a middle ground in terms of how do I keep the scale side of this without completely abandoning what my clientele is looking for. The third one is customization itself, and again, this is all too many words in this space, but customization basically is the idea that you're going to take a model and then you're going to customize around it for a specific investor, and so I think, when you think about what the challenge is with scale, it's the customization piece. Custom models are fine, right?

Damian Cilmi: You still got scale, you still have scale.

Mike Martel: And I think that One of the challenging pieces is the communication side of it. If you overly customize, you lose the ability to deliver the communication from that manager, and so I do think that there's a little bit of a negative impact.

Damian Cilmi: So what's some of the more common ones? You talked about Retirement income, so I could see that one there. On the accumulation space, you said ESG. Is there any other kind of customizations? That's looking common.

Mike Martel: Yeah. So the simplest ones that we get would be ticker swaps. So someone decides that there's a manager that they prefer not to use or someone wants to cap. Well say, someone comes to State Street and says you know, look, I want something more open architecture, you're off the shelf. Asset allocation is fine, lock it, cap's better at 60% or at 50% or something like that. We've also seen clients come to us with a specific manager strategy. So earlier this year we did some work for a client that brought us a managed future strategy and they said look, what would you do? We really love this manager. Can you incorporate it into the asset allocation? So things like that you also have. You know, overall the risk profile could be another thing, depending upon the client. So in the US we might have six points on the affrition frontier. We've had some asked for 10 and you know the extreme that I can share with you is we did some work for a robo once they wanted 100.

And again, it's really all about you know, trying to strike that balance between, you know, getting what's right for the client versus making sure that you're continuing to scale your business.

Damian Cilmi: Yeah, yeah, it's a slightly different tact Due diligence so we do due diligence over managers here. So I imagine you're the target of due diligence from a lot of organizations saying, oh I'd like to partner with you but I've got to do the due diligence. So what are you seeing from trends on inbound DD on you?

Mike Martel: I would say in a word, it's very, very thorough, and I think that what we're seeing is that it's being driven by this belief that when you're generating these model portfolios, it's not all about the product, it's also about the partnership, now. So if you know, if I'm on the other side of the table and I'm trying to assess whether or not you're going to be a good partner for me today, but I also want to know are you going to grow with me? Are you going to evolve with me? How are you going to support me and users, my clients? So that is super, super important. I mean, I can share with you one of our longstanding model relationships that we've had. We do quarterly meetings with them so you can think of those as many due diligence. So over the history we've done 60 with this one client. So again, you can see that just that demand, and I think that's one of the beauties of having these parent organizations that are stepping in and doing the due diligence for the FAs, right? So the financial advisors are already getting, you know, the model portfolio providers screened,

Damian Cilmi: So the head office is doing it Exactly yeah.

Mike Martel: Exactly, which is great. It just speeds the whole process for everyone. You know areas of focus. I can throw a list of things that you're looking at. It's not going to be surprising. It's things like process. People want to understand the same thing. Is it clearly un-? Can I understand it? Is it repeatable, and can you demonstrate that you're actually using the process that you told me you were using? That's an important one.

Damian Cilmi: And especially around asset allocation as well, because that can be a little bit more gray and maybe out of stock selection it's a bit easier to see a kind of flow through Right.

Mike Martel: I completely agree, especially when you have the markets we've had over the last five years, because you know part of the bedrock of the SAA process for us is our long-term asset class forecast. It's one of the key ingredients for us and you know you tend not to see big changes in those long-term asset class forecast by design. But when you get March 2020, when you get 2022, you know you can have these seismic shifts in your long-term asset class forecast, and so you do want to have the ability to have that you know, at least in the annual review where you're assessing the conditions and making sure that you're doing what's best for the clients.

Damian Cilmi: Yeah. You know, being on the other side of it as well. You know we saw obviously people downgrading, expect a return on bonds throughout. You know, say, 2018 to about 21, 22, really, we've seen a little bit of a tick up now the back of 22 into 23 on that one there. So you know, you do, even though you think that maybe they don't move around, but they do, they do.

Mike Martel: Yeah, especially you get these big market events. I mean, look at 2020, I mean, where did interest rates go? They were all crushed, everybody's yield curve was crushed right. And so you know, trying to predict the path of normalization for anybody who's doing strategic, it's challenging. Is it going to be three years, five years, 10 years? It all happened in one year.

Damian Cilmi: So what's the most interesting question or angle that you've had from a DD approach? One where you said I did not see that one coming.

Mike Martel: Oh geez that's a good question. I mean, we get a lot of more standard stuff and I wish I had a better story for you. I'll keep thinking about it and if I can, if I can, if I can think of one, I'll definitely share. But look a couple of things that people want. It goes when you know one of the things that they want to look at is the people that are involved, that's right and you know it's not like it used to be, where it was like. well, our average years of experience is 15, because I think everybody's average is 15. People are really more concerned about how accessible your team is to them, and, you know they want to make sure that they're getting the same team that you're putting out on the field for the institutional clients. They don't want the B team, they want the A team and they want to have the access to that team, which I think is you know it's interesting and it's just an evolution in how this is happening. I mean other things, you know, as I'm looking through the long list of requirements that we get on due diligence. I mean reputation, resources, all the stuff that you've seen. Communication, I think, is a really important one too, and I think there's two aspects of it, making sure that they understand what's driving your performance, but there's also a client education aspect of that as well. Right, and having an asset manager who's going to be committed to actually doing and providing really strong education is really becoming a key ingredient.

Damian Cilmi: Yeah, yeah, yeah. State Street has been, I think, involved with the investment trends report here for four years in a row around manager accounts, so quite the long-standing collaboration there with a very important research report here in Australia. Have you had a chance to have a read of the Australian report? I have got copious notes to share with you, you know if you're looking for them, yeah tell us what was the highlight, especially, and I'm kind of curious about the outside looking in as well, so you can also look at it through that lens. I mean, we kind of live and breathe it from a domestic basis. What did you see as the highlights out of that report?

Mike Martel: Well, I think the really cool thing for State Street is the fact that, since we've partnered with investment trends on this for so many years, we get to ask questions, and so one of the questions I will ask them is to say look, how are we aligning, you know, US versus Australia? What are we seeing between the two, and is there anything interesting? But you know, the one that jumped off the page to me is usage Usage percentages more than tripled. I mean, I think it was 17% just 10 years ago. Now it's 56%. Of advisors are using model portfolios, one in two. Yeah, yeah, two years in a row now. So I think that that's amazing, and when you think about what's driving it, I mean, it's no surprise. It's efficiency and it's the business. And I think that when you look at one of the stats that was in there talked about advisors who have embraced their model portfolios, those who have done it, say, four years ago, last time that we were speaking, say that we inspired someone to use model portfolios four or five years ago.

Damian Cilmi: I think that you did, by the way.

Mike Martel: Well, you know what's the outcome? Well, they're seeing significantly improved client flows. They're generally their average client balances are much larger than people who have been slower to adopt, and that really does speak to that added focus that these enable you to bring to your clients and growing your business. The other one that was interesting time savings. 17 hours a week, that's a big, meaningful number that you can then put back into growing your business. I'm trying to look through anything else here that might jump off the page.

Damian Cilmi: And then the earnings would be up there as well too. If you've got time savings, you see more points. Bigger FUM numbers. So it all should go through, but the bottom line on better earnings for those firms.

Mike Martel: Yeah, no, I mean, I think you're spot on and there was definitely one that jumped off and I just wanted to come down here and find it, because it's basically exactly what you just said that when you look at value props when using managed accounts, 45% of the people surveyed say that they now have greater focus on their clients and their clients goals, and 39% have specified that their value prop changed to outsourcing portfolio construction to professionals because it's better for the business and better for their ultimate clients. So, yeah, some really good stuff.

Damian Cilmi: Good, good, good. And thanks again for participating in that research because it's very valuable for the whole industry. So thanks to State Street for that. We'll start to get towards the end here. We'll kind of have a bit of an outlook question here and I suppose that you know we're probably a couple of years behind what's going on in the States, obviously with quantum, but I think that the growth rates are somewhat similar. But we're seeing a bit of maturity here. But still, what kind of trends should Australian advisors in particular be looking for? That's probably going to come down the pipe.

Mike Martel: I would say one of the big ones, that that we continue to see and we've touched on a little bit is just open architecture. I think that there is growing dissatisfaction, at least on the US side, with the one-stop shop Single issue. Yeah, exactly I think that there's this acknowledgement, especially if you're looking into the active, passive kind of relationship. There's this idea that you know, look, not you know managers aren't great at everything. No one manager can be great everywhere. I mean, maybe you have a good year or two, but at the end of the day, people like to see diversity across the manager side. So I think, you know, preparing for open architecture is certainly one, because that's going to tie back to personalization and things like that as well that we talked about earlier. I think the second thing would be and it's somewhat related, I would say prepare for broader opportunity sets, and really what we're seeing more of now is the whole alts. Whether they're liquid, whether they're illiquid, people are, you know, more and more looking to wrap those in to the model portfolio. Previously you would see them held in that core satellite. Maybe that would be one of the satellites. Now we're being asked.

Damian Cilmi: So like 80 cents in the dollar, just in the model, and 20 cents out in like held through the cycle.

Mike Martel: Exactly, Exactly. But now they're saying, hey, this is. I want you to incorporate this directly into the model portfolio.

Damian Cilmi: A dynamic allocation tool, yeah possibly that possibly.

Mike Martel: I want you to be able to communicate it to me so that I can understand how that's coming. The other side of it is, I think you're going to see proliferation, a more interesting product coming, whether that's delivered in, you know, funds, whether it's delivered in ETFs. I mean, I think that that's certainly something that we're seeing in the US, so private market proliferation as well.

Damian Cilmi: I imagine that's a big thing for you guys too. Absolutely.

Mike Martel: I mean, you can see that everywhere. It's in model portfolios, but it's also on the institutional side where we're doing things like target date funds. You know, just more and more people are looking to see. You know how can you get the private markets, whether it's direct real estate, private equity? How can we bring more of that to the end client?

Damian Cilmi: Yeah, that's what we're seeing here. Do you think those trends, do you think they're unique to the US, or Australia would see them as well?

Mike Martel: I think that question gets down to the individual clients and I think that there tends to be a lot of common ground between Australian investors and US investors. Now, that would have changed

Damian Cilmi: I would say that we're seeing that 100%. Target date. We haven't seen as much of it Like. It's come and gone here a couple of times, but so where do you see target markets working well, or target?

Mike Martel: We've had our first conversation with a potential prospect who wanted to see if you want to talk to us about delivering target date through a model portfolio. That's, again, really, really new and I'm not sure exactly where that's eventually going to land, but I do think that it's the whole idea of how can you make life easier for the end user, and I think target date has always been an interesting one on the institutional side, because it doesn't get any easier than that. I think the big question becomes in retirement now, and I think that that's where you're going to see the intersection of the wealth market and the institutional market Like we may not have seen that previously, because, at least in the US, one of the things we're seeing is that companies are becoming more and more keen to keep participants in the plan post retirement. So rather than rolling out and going into wealth so now what we're seeing is, particularly even within State Street, many more conversations between the team focused on wealth and the team that's focused on institutional, trying to find what's the next big solution that's going to work for you, and that is a debate that's happening here as well, with some of the big pension plans as well.

Damian Cilmi: So yep Good stuff. There you go, mike. Fantastic Once again. Please come back and let's make sure it's not four or five years in between drinks.

Mike Martel : Thank you very much.