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Wrap Trading and Regulatory Risks in a MIFID II World?
Traders Magazine Online News, May 31, 2017
Putting aside our recent election, over the last few years Wall Street has devoted a good deal of attention to the racket being made from across the pond. For PM’s, the reality of Brexit and the threat of Frexit and Ita-Leave have them continually hopscotching across markets. In equities trading, for both buy and sell side traders the looming implementation of MIFID II is potentially redefining research compensation and order handling practices.
In terms of best execution, all hands are on deck for MIFID II as they should be. Except, surprisingly, for the SEC who is not actively planning to address potential conflicts to their regulatory regime. It’s not that they are willfully turning a blind eye to the potential effects the Euro-centric rules will have on our markets. The SEC remains committed to protect investors and maintain fair and orderly markets. It appears though, for now, they prefer to place their focus on important homegrown issues.
One area of domestic regulatory activity in particular that has been drowned out by the ambient noise from Europe is the monstrous yet often overlooked managed account business. In contrast to mutual funds, managed money or “Wrap” accounts allow investors direct access to professional money managers (“sub advisors”) while still maintaining a private portfolio of individual securities in a brokerage account (with a broker acting as the “wrap sponsor”). In essence, investors get the best of both worlds. The sponsor provides them with access to best advice across multiple sub advisors with all assets fully transparent and accessible within one account.
Think of wrap as your own personalized fund. Thousands of qualified investors see it that way and have shifted a good portion of their savings into managed accounts over the last decade.
The Rise of Wrap – Size Matters
With its origins in 1970s, the wrap business was a somewhat obscure and niche product that originally served ultra-high-net-worth investors. The financial scandals and market turmoil around 2008 provided an additional spark for managed accounts, as the Madoff Effect inspired massive hedge fund redemptions and wealthier investors sought greater transparency, control and access to their assets. Today, advancements in technology and efficiencies in the industry have reduced the minimum requirements, expanding the reach and customization of wrap accounts to a much more diverse audience who seek greater tax flexibility and tailored investment planning.
According to the Money Management Institute, the wrap business is huge – totaling $4.6 trillion in assets under management in Q3 2016. For comparison, consider that AUM in hedge funds according to BarclayHedge clocks in at roughly $3 trillion.
Given that the aggregate money managed in wrap now outsizes some more high-profile styles of the investing and there has been a rapid migration from the broker dealer model to the investment advisory model, it’s no surprise the SEC has increased resources to review wrap practices and procedures.
Under Wraps
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