A separately managed account, or SMA, is just what it sounds like: a portfolio of securities that is professionally managed separately from other portfolios. Their targeted nature is one of the key differences between SMAs and mutual funds or exchange-traded funds (ETFs): While an SMA is managed for the benefit of one investor, mutual funds and ETFs pool the assets of many investors. There are plenty of other differences, however, and anyone considering an SMA should review the pros and cons of owning one.
An old concept finds a new audience
SMAs were developed in the 1970s for investors who had an investment objective that mutual funds at the time couldn’t help them pursue. Innovation in mutual fund variety really didn’t take off until the 1980s and 1990s, when funds became the standard investment choices of defined contribution retirement plans. Investors who were looking for something more than a plain-vanilla fund had to either manage their own portfolio of individual securities or give that management responsibility to a professional asset manager.
That’s where SMAs came in. Typically starting with a blueprint of an existing strategy, the SMA could be fine-tuned to the investor’s needs and then professionally managed by the asset manager. The typical buyer in those early days was an institutional investor, but that’s changed. Today, SMAs are commonly served to high-net-worth individuals, and SMA assets under management have passed $1 trillion in the United States alone—an increase of 84% since 2010.1 The many benefits of SMAs explain their renewed popularity.
- —SMAs have more flexibility than mutual funds or ETFs because SMAs are not governed by a prospectus. Typically, a prospectus limits a fund’s strategy to operating within certain guidelines. For example, mutual funds have restrictions on how much of a company’s shares they can own and must meet certain security and sector-exposure requirements to be considered diversified. SMAs are different in that they can have far fewer holdings than a fund and an investor can modify an off-the-shelf strategy to suit his or her needs. While SMAs aren't governed by prospectus, the registered investment advisors who offer them are required to provide investors with an ADV brochure (named after the Securities and Exchange Commission's Form ADV) that outlines information about the advisory firm, fees, services, and the like.
- —Mutual funds are required to pay out net capital gains and accrued income at least once a year, and outside of qualified retirement accounts, those distributions are taxable. Because a mutual fund investor owns shares in the fund and not the underlying securities, he or she has little say in how those distributions are managed or when they take place. And because those distributions often take place with a lag, an investor can buy mutual fund shares after a price decline, thinking he or she got a bargain only to receive a capital gain distribution resulting from the prior year’s activity. An SMA investor, by way of contrast, owns the underlying securities directly, so he or she can work with the asset manager to potentially control and help minimize the distribution of taxable gains—for example by offset gains in one area through tax-loss selling. SMAs may also make in-kind exchanges and deploy other strategies that may help limit an investor’s tax liability.
- —Mutual funds are required to list their complete holdings each month on a publicly available website, but these listings typically post after a delay of 30 to 60 days, with a fund’s 10-largest holdings displayed sooner. ETFs are required to list holdings daily. Because an SMA investor owns the underlying portfolio holdings directly, he or she can view those positions at any time. SMAs also typically detail fees and performance separately on a quarterly basis, offering a clear view of the investment’s ongoing expense.
- —Fees are generally lower for SMAs than for actively managed mutual funds, in part because SMAs aren't responsible for all the regulatory reporting and administration associated with funds. How much lower? According to Cerulli, the average SMA management fee ranges from 0.25% to 0.45%, versus 0.68% for mutual funds. It’s important to remember that a financial professional’s fee, often 1% of account assets, will be added to the management fee of the underlying investment.2
- —At this point, you may be wondering why you’d ever invest in anything other than an SMA. The price of entry is a big reason why. SMAs typically require a minimum investment of at least $50,000 and these minimums are often are as high as $5 million. (Generally, accounts with higher minimums allow for more customization.)
- —The regulatory framework surrounding mutual funds and ETFs was put in place to protect investors from abuses and other potential shortcomings of asset managers. For example, a mutual fund’s board of directors is responsible for regularly and independently evaluating the performance and fees of a fund. (Is the fund sticking to its charter? Are the fees charged justified by the services provided?) A fund’s board even has the ability to fire and replace an asset manager if need be. Funds and ETFs also have to report their operations to—and are subject to random checks by—the Securities and Exchange Commission (SEC) in the United States and other regulators elsewhere. These regulatory bodies enforce strict rules around insider trading, self-dealing, and myriad other harmful practices. SMA investors forego some of these protections in exchange for a higher degree of portfolio transparency, direct ownership of shares, and a more personalized relationship with the portfolio management team.
- —The relative lack of oversight with SMAs can make it harder to assess differences in offerings from one advisor to another. For example, the fees that an advisory will add to an SMA account will vary from firm to firm, without a set of standards established by a regulatory body like the SEC.
- —Despite the pickup in investor interest in recent years, SMAs constitute a much smaller universe of options than mutual funds and ETFs. That means that even if you like the concept of an SMA and can afford the minimum investment, you might not find a strategy that works for your situation.
An SMA can be an appropriate solution for an investor who's looking for a more tailored approach and has the capital to invest. Your financial professional can help determine whether an SMA is right for you, help you navigate the available options, and help you take the next step.
1 The State of the U.S. Retail and Institutional Asset Management Report, Cerulli Associates, 2019.
2 Cerulli Edge, 2019.