Minute Read

What is an SMA, and is it Right for You?

March 30, 2022

Kousha Bautista-Saeyan & David Darby
By Farther Committee

What is an SMA?

When considering the diversification of portfolio holdings, most advisors and their clients are familiar with mutual funds and exchange traded funds (ETFs). There is a third category of investment funds that can be useful, however, when utilized  appropriately: separately managed accounts (SMA’s).

SMA’s may look very similar to mutual funds and ETFs with one primary difference: an SMA is not a pooled investment vehicle, but is instead an account owned wholly by an investor with an individual position held in the account. Thus, an SMA investor holds direct ownership in the account’s assets, as opposed to owning shares of a mutual fund or an ETF with underlying ownership. This structure allows for more flexibility, transparency, and tax-efficiency for the SMA investor. Similar to mutual funds and ETFs, SMA's can be used to invest in both actively managed strategies (in which a manager is trying to beat an investment benchmark) and passively managed strategies (in which a manager is trying to match an investment benchmark’s performance).

How can an SMA be useful?

  1. Customization: Some SMA managers offer customization of the underlying investment exposures to fit investor preferences. An SMA can be used tactically, allowing for it to complement existing mutual funds, ETFs, and individual holdings in a portfolio. For example, a client mandate around responsible investing or concentrated stock holdings can be more easily customized in an SMA.
  2. Tax Management: Some SMA strategies harvest tax losses, which investors can use to offset their capital gains from other investments in a portfolio, while deferring long-term capital gains.
  3. Transitions and Charitable Giving: Individual stock positions can be easily transitioned into many SMA portfolios without having to sell the securities and generating a tax event. The tax-managed strategies that focus on deferring long-term capital gains lead to opportunities for charitable giving, using the most appreciated stocks in the portfolio.

What should I be aware of when utilizing SMA’s?

  1. Fees: It’s important to evaluate the prospective value of an SMA investment and determine whether it’s worth the fee that investors pay for the strategy. Actively managed strategies generally have higher fees than passively managed, index-oriented strategies. How likely is it that an active manager will outperform the market by more than their fee? Similarly, will a tax-managed strategy improve your after-tax return by more than their fee? Passive stock-market mutual funds & ETFs have management as low as .03%. Looking at performance, net of fees, is an important metric when deciding on the best vehicle to use for your investments. It’s appropriate to only use SMA’s in areas where you have a high degree of confidence that the strategy can add more value than the fee.
  2. Limits to customization: While many SMA managers will allow for individual security customization, an investor is still limited to the mandate set forth by the fund manager. Your advisor should inquire as to which restrictions can be placed, before you decide on an SMA and invest in the fund.

While SMA’s will not be the right investment for every investor situation, they are another tool to add to your investment toolkit. Our team here at Farther believes that your financial advisor is your best guide to determine how best to use SMA’s, and we encourage you to reach out to us today to discuss your wealth goals!

Kousha Bautista-Saeyan & David Darby

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