When to Use Separately Managed Accounts

For financial advisers, SMAs are an option for higher net worth clients and they can be tailored to a client’s needs.
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Separately managed accounts or SMAs are an investing solution that is becoming increasingly popular among many investors and their advisers. SMAs can be an option for higher net worth clients and can offer an option for advisers who are looking for a managed account solution that can be tailored to their client’s needs.

SMAs vs. Mutual Funds and ETFs

Both SMAs and mutual funds are types of professionally managed investment accounts. The main difference is that mutual funds and ETFs are that one size fits all. These are managed investments that are offered to the public and that portfolio is the same for any investor that purchases them.

SMAs are also professionally managed investment accounts, but they offer a high level of flexibility and can generally be tailored to the needs of an individual client. SMAs might be managed to a particular investment style like a mutual fund or an ETF, or in some cases may be managed as a broad comprehensive portfolio.

With an SMA, your client has direct ownership in the securities held in the portfolio, this offers a number of advantages as opposed to investing in mutual funds and ETFs where all securities in the portfolio are pooled together.

Customization and Control

One of the advantages of SMAs is the ability to customize the portfolio to your client’s situation.

As an example, you may have clients with large concentrated positions in their company’s stock. Perhaps they are long-term employees of the company or have received significant levels of stock-based compensation. This type of concentrated position can skew the allocation of a client’s portfolio. A customized SMA can be structured to exclude this company from the portfolio and can even exclude other stocks in this industry if appropriate to help provide your clients with a more appropriate overall allocation.

A client investing in an SMA focused on muni bonds could have the manager concentrate holdings in a certain state, plus tailor the account’s duration and other factors to your client’s situation.

Tax Efficiency

The individual ownership of the portfolio’s securities allows the SMA manager to manage the sale of securities in the account in a fashion that may be more advantageous to your client. For example, the manager can use tax-loss harvesting to offset gains elsewhere in the account to help the client manage their tax liability.

Transparency

Mutual funds only report their holdings a couple of times per year as required. Owners of SMA accounts receive regular updates on the account’s holdings including the performance of those holdings. This allows you as an adviser and your clients to fully understand how their money is invested and what the SMA manager is truly doing.

Investing Based on Client Values

The transparency and ability to customize the SMA portfolio offers the opportunity to tailor the account to reflect the client’s values if applicable. For example, if there are companies or industries that would violate the client’s religious convictions, they could be excluded from the portfolio. Clients who would like to focus on certain ESG issues could have these wishes adhered to in constructing the portfolio.

While there are mutual funds and ETFs that claim to invest based on religious, ESG or other themes, these funds are one size fits all. Not every investor with these or other concerns are the same. The SMA structure allows for a more tailored level of customization for these clients.

Why use SMAs?

SMAs are not right for every adviser or every client. For advisers who typically take a hands-on approach to managing their client’s investment portfolios, SMAs are probably not a good fit. Additionally, SMAs typically will have a higher minimum investment than mutual funds.

That said, for advisers who outsource some or all of the investment management of their client’s portfolios SMAs can offer another option to consider.

SMAs might be used for a specific portion of the client’s investments, perhaps fixed income or a focused equity allocation. The ability to work with the SMA manager to customize the account to fit the client’s specific investment needs in a specific area, or broadly, makes SMAs a viable option for advisers who outsource all or part of their client’s investment manager to a third-party.

A Few Cautions

As your client’s adviser, it's up to you to ensure that the SMA manager that you select is the best one for your client’s needs. As such it’s important that you:

  • Review and understand the SMA managers track record overall and as a manager in the type of portfolio that you are considering for your client.
  • Be sure to understand all of the expenses associated with the SMA to be sure they are reasonable.
  • Before recommending an SMA to a client, be sure that you are clear as to any liquidity issues or other account restrictions that might be involved.
  • Understand how you and the SMA provider will communicate and how you can best work together to ensure the account is managed in the best fashion for your client.

SMAs can offer another investing alternative for all or part of your client’s portfolio. As with any type of investment you might suggest to them, it's important that you perform your own thorough due diligence up front to ensure this is a solid addition to your client’s investing efforts.