Fresh off of a competitive basketball game on Morgan Stanley Smith Barney's sprawling Purchase, N.Y. campus, Paul Hatch says it is just as important to fail as it is to win.
That may sound strange to hear from Hatch, who currently oversees one of Morgan Stanley Smith Barney's most successful businesses as part of his role as managing director and head of investment strategy and solutions. That business, Consulting Group, has consistently ranked number one over the competition in managed accounts.
"We fail often and we fail quickly," Hatch says. "Many things that have failed we figured out very quickly weren't exactly what the consumer wanted. But we were able to figure out what they were, and then move quickly into those."
Quickly is just what Morgan Stanley Smith Barney plans to do as it focuses on growing its Consulting Group division, where it aims to double the assets in the managed account group to more than $1 trillion within the next five years.
Specifically, that calls for $500 billion in new assets in the next five years. In recognition of those numbers, the firm has dubbed its strategy the "5 in 5 Campaign." Obviously, the goal is aggressive. Consider that Consulting Group had $1.6 billion in assets in 1981, which rose to $42 billion in 1991, and $241.6 billion in 2001. Today, Morgan Stanley Smith Barney says its Consulting Group's fee-based assets totaled $509 billion as of the second quarter of this year. Bank of America Merrill Lynch, is well behind in second place with $ 403.4 billion, according to Boston-based research firm Cerulli Associates.
To reach that $1 trillion goal, Hatch enlisted James Walker to serve as managing director and director of Consulting Group in September 2010. Before that, Walker had served as chief operating officer of investment strategy and solutions at the firm under Hatch.
The two also share a Citigroup heritage. Hatch came to his current role in 2009 from his position as head of investments at Citi Global Wealth Management. Before joining Morgan Stanley Smith Barney, Walker was director of finance, risk and strategy for Citi Global Wealth Management Investments.
Together, they developed the plan to increase Morgan Stanley Smith Barney's managed account assets. They were inspired by the prospective flows that the Morgan Stanley and Smith Barney combination, first formed in 2009, could generate. The plan also ties in with a new regulatory reality, where advisors could be held to a heightened fiduciary standard.
Even with the unpredictability of upcoming new regulations and market conditions, both Hatch and Walker are confident in their five-year target to reach $1 trillion in assets. "We're very comfortable with this five years," Hatch says. "Nobody in the industry could come close to this. We know that, but we just believe that culturally, this is the right thing for us to do."
From Failure To Success
One of the most prominent examples of a Morgan Stanley Smith Barney success born from failure is its unified managed account program, now a successful part of its managed accounts group. When the UMA accounts that exist today first took off in the industry about seven years ago, Hatch says, the firm was not the first to market, even though they had developed a form of the account years as early as 1997.
The path to success was not necessarily smooth. As the firm moved toward other versions of the UMA product, they found they were too complex, requiring too many signatures, generating too many reports and presenting complicated pricing. Ultimately, clients and financial advisors were not choosing to use it.
"We had a couple billion dollars in it, and that sounds like a success, but for us a couple billion dollars is not a success," Hatch says. "For us, a couple billion dollars is a failure," he says. "We figured out very quickly as we incorporated it into the marketplace, made a very quick switch and literally changed 180 degrees in our approach and were able to bring out the industry-leading UMA shortly thereafter. By the way, we would have never had the industry-leading UMA without making that mistake."
The idea for Morgan Stanley Smith Barney's current UMA account first began in 2007, followed by predecessor firm Citigroup's early 2008 acquisition of Legg Mason Inc.'s Private Portfolio Group. That deal brought in the "best overlay technology," which took about a year to process, Walker says.
And it is better technology that has put Morgan Stanley Smith Barney's UMA product in the lead. The firm has buried the upfront complexity that was once a deterrent to both advisors and clients when they would initially access the accounts, Walker says. But more complex options are still accessible to those who want those features. The product also offers three levels of discretion that can put all investment decisions under the control of the client, the firm or the advisor.
Today, Morgan Stanley Smith Barney leads the industry in the UMA space, with $45.9 billion in assets under management and a 35.6% market share as of the end of the first quarter this year, according to Cerulli Associates. When compared to other wirehouses, Bank of America Merrill Lynch comes in second with $20.9 billion in assets under management and 16.2% of the market; followed by Wells Fargo Advisors with $10.3 billion and 8%, and UBS with $5.8 billion and 4.5%.
Another success born from failure was the Smith Barney Advisor account, Hatch says, which the firm launched in 2005 in anticipation of a regulatory rule that happened two years later in 2007, known as fee in lieu of commission brokerage. Developing a non-discretionary account product that coincided with that change allowed the firm to capture $40 billion in new assets in two years, succeeding the firms that had been ahead of it. The ability to turn around Smith Barney Advisor and the UMA product comes from the firm's ability to quickly adapt to market forces, according to Hatch.
"We have the same advantage in the managed accounts space, because we've been doing it for so long," Hatch says, "because our branch managers grew up doing that business, our regional directors, all of our product people."
The Math Works Out
Morgan Stanley Smith Barney plans to draw on that advantage as it seeks to double the assets in that group in the next five years, similar to the innovation cycle the firm started to get to its current UMA product.
To reach its $1 trillion goal, Morgan Stanley Smith Barney took the flows, or net amount of dollars going into the business, after forming the joint venture. By assuming the markets will give them a modest 5% based on their current flows and expected macro conditions, Walker says, that is how they arrive at their target, and greater momentum for the business.
"The math works out over a five-year period, and that's meaningful," Walker says. "What happens is if you're at $1 trillion in overall managed assets, the recurring revenue stream and the focus and the complexion of the revenues starts to look different overall for Morgan Stanley Smith Barney, but it also feeds the investment in the platform, the investment in the business."
How much revenue Consulting Group currently brings into Morgan Stanley Smith Barney is not disclosed. The business is part of the firm's asset management, distribution and administration, which represented $1.8 billion of the $3.1 billion total non-interest revenue reported by the firm in the second quarter.
The plan comes as Morgan Stanley has increased its assets in advisory to 30% from 26% in the last year alone, Hatch says.
That 30% coincides with the level where other leading firms have grown their managed assets business, says Alois Pirker, research director at Boston-based financial services research firm Aite Group, where the last 10% increase has taken some time but should accelerate as firms grow it by another 10% or 20%. "I wouldn't be surprised if they were at 50%, say a couple of years down the road," Pirker says of leading firms. "There's definitely much more of a dynamic in that shift towards a fee-based [model]."
The strategy also comes as wirehouse firms have lost market share in managed accounts over the last decade, according to Cerulli Associates. In 2000, the wirehouses held 72% of the assets compared to independent broker dealers, regional firms and banks, among others. Today, wirehouses represent around 56%.
"They continue to lose market share, but they still have the lion's share of managed account assets," Patrick Newcomb, a senior analyst at Cerulli, says. "Over the next several years, we have the wires losing market share, [while the] independent channel will kind of grow a little bit."
Discount channels including E-Trade Financial Corp., Fidelity and Charles Schwab & Co. also show promise for grabbing more of the market in coming years, Newcomb says. Even with that growth, the wirehouses are still slated to remain the largest channel. Could Morgan Stanley Smith Barney still hold the top position in five years? "I would think most likely they will be," Newcomb says.
Part of what helps Morgan Stanley Smith Barney maintain its edge in this area is its Graystone Consulting business focusing on institutional investments, which in turn helps the firm provide more sophisticated services to the individual investor market, Hatch says. Graystone, currently with $150 billion in assets, was created under Citigroup's institutional consulting business in 2006. Graystone serves high endowment and foundation client assets, as well as associations, Taft- Hartley plans, state and municipal governments, and health care and religious organizations, as well as some family offices and high-net-worth individuals.
The five-year plan ties in with the possible regulatory enforcement of a uniform fiduciary standard. The managed accounts business could offer a more streamlined way to fall in line with those regulations, through fee-based advice offered on multiple kinds of investments.
At the same time, the five-year strategy also comes as more investors and financial advisors are forming discretionary relationships, where the advisor takes charge of managing the accounts and making investment decisions. Advisors are already attracted to that model, which can result in more efficiency, Hatch says.
"In addition to having client outcomes that are better, advisors who tend to adopt a discretionary business model don't have the same challenge of calling every single client about an investment idea," Hatch says.
As the firm strives to make its relationship with clients more productive, it is also investing in technology that will boost productivity behind the scenes.
That includes adopting a third party technology to allow Morgan Stanley Smith Barney's advisors to see all of a client's assets in real time, not just the accounts they work with directly. If a client has a relationship with another bank or 401(k) assets held by another firm, the advisor can factor that into the advice they give the client.
The concept of evaluating all of a client's assets is not new. Clients have been sharing their statements with financial advisors for years. But the technology will allow Morgan Stanley Smith Barney's advisors to monitor those assets in real time, while not requiring a client to give up their relationships with other custodians.
It is an example of a technology that will be better than what the firm could build on its own, Walker says, and contributes to client satisfaction, though they will never hear of the product. It is part of the firm's larger efforts to make its services more client-friendly, including a redesign to its pricing structure last year to simplify explanations to clients on what they will pay.
"The client doesn't come to us and say, 'We want [this technology],'" Walker says. "They come to us to solve problems, and so this is something that happens behind the scenes."
Internally, Morgan Stanley Smith Barney is also adopting other technologies to improve efficiency, including systems to enable benchmarking of the individual performance of its financial advisor force that totaled 17,638 as of June 30. That will that allow the firm to see how well each advisor is serving their clients, Hatch says, and can also lead to noticing where successful strategies are happening and sharing those methods throughout the firm.
The Advantage of Scale
The firm's massive merger has also led to stronger practices and products superseding others. "The analogy I would say is you pull the engine out of the car, and before you put it in the new car, you kind of rework everything," Walker says. "You have to rethink everything. Everything. Every process, every form, every technology platform had to be reconstituted."
Though Smith Barney had the lead in the wealth management business of the two firms going into the merger, it was Morgan Stanley that had the stronger upfront interface to run rep as portfolio manager accounts. The joint venture wound up taking its front end and merging it with the back end of Smith Barney's system — platform by platform — which took an enormous amount of time, Walker recalls.
And that is just one example of a major decision the firm has been forced to make as it integrates the two firms: choose one method, another method or create a third, better option. Ultimately, Hatch says, that led to better decisions and more productivity, with more new products introduced by the firm from 2007 to 2010 than it did in the previous decade.
"When you're just kind of going along and doing business as usual, you don't challenge yourself that way," Hatch says. "Part of the challenge of being the innovator all the time is you have to constantly make yourself obsolete, and that's hard to do in a large organization that's very successful like ours."
As Morgan Stanley Smith Barney embarks on its plan that means keeping close tabs on competitors of all sizes. It also will mean drawing on its large financial advisor force and other employees, Walker says. "Five years is a long time. It's an eternity, in fact," he says. "Let's assume that whatever 'normal' markets will be, like no major 2007, 2008 crisis and no major bull market, five years is doable. And a great market would make it easier. It would make it a lot easier, but we're not planning on that."