Understanding Separately Managed Accounts

SMAs can provide investors with many of the benefits of pooled vehicles, such as exchange-traded funds (ETFs) and mutual funds, while introducing a high degree of flexibility, customization, and control. Thanks to technological innovations, falling investment minimums, and fee compression (including in some cases low/zero trading commissions), SMAs are now accessible to a broad array of investors. The following summary aims to help you better understand the SMA structure and consider the scenarios where SMAs can be a helpful addition to your clients’ portfolios.

How SMAs work

With mutual funds and ETFs, an investor is a partial shareholder in a professionally managed fund that owns a diversified basket of securities. A client with just $100 in their account can own thousands of stocks in a single fund—very powerful diversification.

With SMAs, instead of owning a share in the fund, clients own the individual securities (stocks, bonds) in their account. These accounts are professionally managed by an SMA manager who is granted trading access to the account. The SMA manager monitors the account, rebalances the portfolio, and raises/invests funds for client-requested withdrawals/deposits. To get proper diversification and to keep management fees down, account minimums tend to be higher in SMAs.

SMAs are available for a wide range of asset classes spanning public equities, fixed income, and cash. SMAs can seek to generate alpha through active management, like many mutual funds, or they can seek to provide an index exposure through passive management, like many ETFs.

Regardless of exposure, account activity is summarized in supplemental statements that detail what you own, how the strategy is implemented, and how much you paid for it.

Customization

ETFs and mutual funds are available in a wide range of flavors. US. International. Emerging. Taxable fixed income. Municipal fixed income. Sectors ETFs. Factor strategies. You name it, an exposure likely exists.

SMAs may allow investors to access these same strategies while personalizing them to their specific needs. Don’t want to own any municipal bonds with a maturity longer than seven years? Check! Unable to own a specific company due to employment restrictions? No problem! Need to express a specific value (environmental, religious, personal, or otherwise) across the portfolio? Again, easy!

SMAs often provide access to experienced portfolio management teams that can build custom mandates tailored to their requirements. These customization capabilities can span asset classes, empowering investors to voice their priorities across the whole portfolio in a coordinated manner and visible in real time.

Control and tax management^*

Tax efficiency is perhaps the most valued element of SMAs. SMAs can be funded with cash or existing securities. Funding with existing securities, an “in-kind transition,” allows investors to shift their portfolios to a new strategy without the tax cost of liquidating highly appreciated securities. This lets an investor replace an existing manager or evolve their existing strategy over time while deferring embedded capital gains and avoiding a potentially substantial tax burden.

In addition to deferring capital gains, direct ownership allows for continuous (or systematic) loss harvesting. The capital losses realized in an SMA flow through to the individual investor’s tax return and provide the opportunity to offset gains realized elsewhere in the portfolio. Where appropriate, this can have the added benefit of improving after-tax returns.^* In contrast, mutual funds and ETFs are unable to pass through losses to end investors—only capital gains. This is key since taxable investors keep the returns earned only after taxes are paid.

Things to consider

SMA investors typically pay an investment management fee that is charged as a percentage of their separate account value. This fee is reflected as a line item on the account statement. SMAs do offer potential fee savings relative to other investment vehicles but in some cases, they can be more expensive.

Take special care when selecting an SMA for passive management, as ETFs may be the most cost-effective way to access an index exposure for many investors. Before choosing an SMA, make sure that the customization and tax efficiency benefits outweigh the fee differential.

Finally, SMAs are more complex to implement, while ETFs and mutual funds are easily purchased and sold at most custodians.

Putting it all together

SMAs have been around since the 1970s. By no means a new investment structure, recent trends are making SMAs more accessible to a new and broader group of investors. SMAs allow investors to know what securities they own, for how long they have owned those securities, and exactly what they paid to purchase them. SMAs permit broad customization and are defined by their inherent flexibility and potential tax efficiency. SMAs empower individuals to leverage institutional expertise geared to the specific needs and expectations of each investor, and we believe these unique characteristics will lead to SMAs as a category to continue growing as part of the investment pie.

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