April 11, 2002
Book Review: Investing in Separate Accounts
by William Baue
A new book extols the merits of separate accounts, which may represent an attractive alternative to
mutual funds for institutional investors and high net-worth individuals.
Erik Davidson and Kevin Freeman, co-founders of Separate Account Solutions and co-authors of
Investing in Separate Accounts (with Brian O'Connell), describe the birth of separate
accounts, or individually managed portfolios, by tracing the history of their predecessor, mutual
funds. The introduction of mutual funds in 1940 opened the door for average investors to emulate
the wealthy by enabling the purchase of a pool of stocks. Mutual funds' popularity took off in the
1980's with the advent of the 401(k) plan and continued through the bull market through the 1990s.
However, outside retirement accounts, mutual funds can present tax inefficiencies, significant load
fees and, recently, mixed financial performance.
Separate accounts mimic mutual
funds by pooling diverse stocks. However, mutual funds also pool the assets of numerous clients,
resulting in a constant influx and outflow of money that triggers buying and selling.
Additionally, fund managers may tinker with the stock blend in attempts to maximize overall
performance. Ironically, according to the authors, the gains from such tinkering may be offset by
potential tax burdens, depending on the timing of capital gains. Davidson and Freeman claim
separate accounts avoid these liabilities through personalization, so that trading occurs only when
it benefits the investor--especially tax-wise, when transactions can reduce capital-gains taxes.
With minimum investment thresholds of $100,000 (though some separate accounts programs
offer minimums of $25,000 to $50,000), separate accounts are not geared toward the average
investor, but rather toward institutional investors and high-worth individuals.
separate accounts are customizable, they may be attractive to investors practicing socially
responsible investing (SRI), as they can tailor their portfolios to match their values.
"To the extent that each separately managed account is customized, one could argue that each
and every separate account [could be] SRI in that it reflects the investor's preferences," said Mr.
Davidson. "[If] one has strong feelings about alcohol, tobacco, the environment, human rights,
abortion, weapons production, racism, sexism, et cetera, those views are reflected in the portfolio
via very objective 'negative declarations'--for example, no IBM, no Microsoft, no tobacco industry,
no defense industry, no forestry industry, no oil industry."
As with mutual funds,
however, employing positive screens is more difficult than employing negative screens.
"Subjective screens such as 'no companies that harm the environment' or 'only companies that
promote affirmative action' are much more problematic since no specific company or industry is
named," said Mr. Davidson. "Therefore, most money management firms will only accept objective
screens and usually only as negative declarations."
As with other social investments,
there is evidence that SRI separate accounts offer competitive financial returns. Last year, SRI
World Group (the company that operates SocialFunds.com) performed a financial comparison of
screened and unscreened separate accounts from money management firms that offered both options.
The results of the analysis indicated that investing in screened separate accounts did not have a
Money management firms offering SRI separate accounts include the
following: Walden Asset Management, State Street Global Advisors, Frontier Capital, Harris Bretall
Sullivan and Smith, Delaware Investments, Roxbury Capital, Calvert Asset Management, Gabelli Asset
Management, and SKBA Capital Management.
You can purchase this book at Amazon.com
Investing in Separate Accounts by
Erik. H. Davidson and Kevin D. Freeman with Brian O'Connell. McGraw-Hill, 2002.