What are Separately Managed Accounts and why are they like a good haircut?

If you have ever had a bad haircut as I have, then you likely appreciate the value of a hairdresser or barber who knows your preferences and understands how any waves, curls, (or lack of them) will affect how the cut will ultimately look. There’s a reason most people return to the same salon or barbershop time and again: we all have our personal tastes, and we want the service we receive to be customized to us – the shape of our heads, the consistency of our hair, and the look we want to achieve.

How does this relate to investing, and more importantly, to the growing use of Separately Managed Accounts (SMAs)? A SMA is a portfolio of securities managed by an investment firm on an investor’s behalf. Unlike a mutual fund or Exchange Traded Fund (ETF), the investor directly holds the securities in the portfolio, allowing for a customized selection of names.

Customization has become one of the primary characteristics of our modern life. We’ve all come to appreciate the custom experience in so many of our goods and services: from our morning coffee to the playlist on our smartphones, from the viewing suggestions on our streaming service to the myriad of choices in home furnishings, car accessories, and personal technology.

Investors too have been demanding a more personalized client experience, and investment portfolios that reflect their unique goals, circumstances and preferences. Just as someone with curly hair needs a different kind of cut than someone whose hair is straight, a young, employed and married investor needs different guidance and a different portfolio than a widowed, middle-aged investor contemplating retirement.

Indeed, the value of a customized client experience is one of the pillars of our annual Value of an Advisor study. Financial advisors are no longer just stockbrokers selecting from a variety of investment solutions for their clients, many of you are now providing holistic wealth management services to your clients and their families. This may include planning for future big-ticket purchases, health needs, lifestyle and legacy, to ensuring their investments receive the smallest tax bite possible. To extend my original analogy—at one time a barber may have given a brush cut to every 12-year-old boy who entered the shop, but now is likely to be providing anything from a faux hawk or flattop to a temple fade or even shaving a unique design on the scalp. 

What are the benefits of Separately Managed Accounts?

SMAs allow advisors to provide that level of customization to each client in a flexible, scalable, and personalized manner. While they have long been used among high net worth and institutional investors, changes in technology have made their use more feasible with a wider group of investors.

Indeed, they are rapidly becoming a key tool for advisors who are shifting their value proposition away from just picking stocks to a more service-oriented relationship with their client. SMAs allow you to match investment strategies with each client’s unique needs and values. Unlike a mutual fund or ETF, a SMA allows the investor to directly own a select basket of securities tailored to their circumstances and goals.

That means if you have a client who doesn’t want to own a specific company, or any company in a specific sector, or wants to avoid a conflict of interest with their employer, then you can use a SMA to achieve this goal. For example, I worked with an advisor whose client doesn’t want to own any oil or gas companies. It didn’t matter to her how well the energy sector was doing this year. She wanted these companies excluded due to her strong support for environmental causes. With a SMA, this was totally doable.

Of course, we did have to let the client know that excluding the energy sector from her portfolio would impact the tracking error and performance she would see against the selected index. Because of her firm conviction against oil and gas producers, she accepted those consequences – be they detrimental in this particular case, or positive in other cases.

Separately Managed Accounts vs. ETFs

Not better, not worse, and not equal. Both SMAs and ETFs can serve a purpose for investors.

ETFs may suit the investor who is seeking lower fees and index-like performance. But like a mutual fund, it is a commingled vehicle, which means every investor who purchases it has the same experience. All receive the same performance, tax treatment and transparency.

With a SMA, however, even though the securities held in the portfolio may be constituents of a particular index—the S&P 500, for example—there can be significant variations. The SMA is likely to hold only between 250 and 300 names rather than 500. That’s enough to mimic the index’s characteristics but not track the index exactly. At Russell Investments we start with the selected index and then determine exclusions based on the client’s preferences.

SMAs also provide greater transparency into an investors’ holdings than an ETF. This is where you, the advisor, can play a key role. While an ETF or mutual fund will only report holdings every quarter or so, a SMA will provide regular updates on the holdings and their performance. This can give you an opportunity to discuss with your client exactly how the portfolio is doing and whether they would like to make any future adjustments. This is a granular level of control and has the potential to help you forge a stronger relationship with your client

Finally, the individual ownership of the securities allows the manager of the SMA to tactically use tax-loss harvesting techniques to offset gains elsewhere in the account or gains in another part of the household’s portfolio. This can help manage the client’s tax liability and potentially maximize their after-tax wealth.

As our annual Value of Advisor study also notes, advisors who help their clients minimize the tax bite they receive can add significant value. An SMA can help you tick a number of boxes!

The bottom line

Progressive advisors know that changing demographics, the generational transfer of wealth, improved technology, and evolving investor demands mean their value proposition needs to keep up. What they have done in the past may not work for them in the future.

Using SMAs for certain clients can help them boost their value proposition because of the ability to meet specific needs, the increased transparency, the flexibility to align a portfolio with a client’s convictions, and the potential for greater tax efficiency.