For many investors, mutual funds and exchange-traded funds are the only investment vehicles they know. For some investors, a third option exists to access financial markets through a separately managed account (SMA). Below we discuss the benefits of an SMA in building an investment portfolio, benefits our clients enjoy, and how it differs from mutual and exchange-traded funds.
Personalized approach – Most mutual fund investors will never speak with the person managing their money. They are one of many thousands of shareholders, only the largest of which might merit the attention of their fund manager if they have any questions about decision-making or wish to learn more. SMA investors have a different experience. Many SMA managers are small business owners like us who tend to be more involved with clients and day-to-day operations. Thus, SMA managers can reduce the multiple levels between client and portfolio manager to create greater accessibility, with many having one-on-one working relationships.
Direct ownership – With a mutual fund, the fund is the owner of any assets. Your money is pooled with other investors, you hold shares in the fund, and you are one step removed from your investments. With an SMA you retain direct ownership of the securities in your account. The assets in your account are registered in your name, not that of a fund. You will receive regular, comprehensive reporting, including your account’s buying and selling activity. Your account statements show the securities you own, the number of shares, and many other details. And you can check this information at any time. All this information and communication leads to greater transparency and serves as the basis for a better understanding of what you own.
Greater portfolio knowledge – When you partner with an advisor to help manage your investments, it is wise to stay knowledgeable about your holdings, understand the logic behind the decisions, and recognize how those decisions will help you reach your goals. Mutual fund managers communicate quarterly in writing, but it relates only to the fund and not its effect on your portfolio. It offers no opportunity for a learning dialogue. With direct and personal access to the SMA manager, you can dive as deeply as needed to reach an appropriate comfort level and better understand how the selections will impact your portfolio. Better knowledge helps frame reasonable return expectations and limit unpleasant surprises.
Customization – an SMA is not a one-kind-fits-all. It can be structured to exclude certain investments due to concentrated single-stock positions elsewhere. It can be structured to reflect personal values, restricting companies deemed less socially responsible or targeting companies that promote and support certain environmental, social, or governance practices. Or a client investing in an SMA focused on muni bonds could have the manager concentrate holdings in a specific state, plus tailor the account duration and other factors specific to the client’s situation. Mutual funds will offer no such customization.
Tax efficiency – Unlike a mutual fund where capital gains from the portfolio are passed along to all shareholders in any taxable accounts, an SMA investor only pays taxes on realized gains in their specific portfolio. Because an SMA contains individual securities, you and your manager can decide when to take capital gains and losses based on your yearly tax situation. Or, instead of realizing capital gains, you can direct your manager to contribute appreciated securities to the charity of your choice. Doing so avoids capital gains tax on the sale and helps meet gifting commitments simultaneously.
Cost competitive – SMA management fees are competitive with, and often less than, the fees charged by advisors using mutual or exchange-traded funds. For instance, many advisors charge an advisory fee in addition to mutual fund fees, creating two layers of fees. SMA manager fees often charge a single, lower fee for advisory and investment management services. SMAs used to be treated as an investment vehicle for high-net-worth investors with a matching cost structure, but they are often less expensive as they have become more available for smaller investors. Consider whether your advisor offers other services in their fee structure. And with trading costs at firms like Schwab and Fidelity going to zero, minimums for an SMA are lower than ever.
Are there disadvantages? A few. First, while the minimums required to benefit from an SMA have dropped over the decades, it still requires at least $100,000 to obtain a broadly diversified portfolio. Below that level, mutual funds or exchange-traded funds are more efficient products. Second, because you own each security in your portfolio, the reports may be longer than for a portfolio that only uses funds. However, that depends mainly on the reporting used by your advisor and may not be a disadvantage for you.