What Is Separately Managed Accounts?
Separately managed accounts (SMAs) represent a professional approach to portfolio management where an investment manager oversees a portfolio of individual securities for a single client. Unlike pooled investment vehicles such as mutual funds or exchange-traded funds (ETFs), the assets within an SMA are directly owned by the individual investors rather than being part of a collective pool. This structure falls under the broader category of investment management, offering a high degree of customization for clients seeking tailored investment strategy and direct control over their holdings. Separately managed accounts are designed to meet specific financial goals, risk tolerances, and tax considerations for the investor.
History and Origin
Separately managed accounts, while seemingly a modern investment solution, have roots tracing back to the 1970s. This period saw the financial industry begin to cater more specifically to the individualized needs of affluent investors who found the constraints of traditional pooled investment vehicles limiting. E.F. Hutton is credited with pioneering the concept in 1974 by introducing "consulting services accounts" to retail customers, marking a significant step towards personalized investment management.8 This innovation provided a pathway for clients to have their brokerage accounts directly managed by investment professionals, moving beyond the standard brokerage or mutual fund offerings of the time. The evolution of separately managed accounts has been driven by increasing demand for customized portfolios and advancements in technology that make such individualized management more feasible.
Key Takeaways
- Separately managed accounts (SMAs) offer direct ownership of individual securities within the client's portfolio, distinguishing them from pooled funds.
- SMAs provide significant customization options, allowing for tailored investment strategies based on an individual's financial objectives, risk profile, and ethical considerations.
- The direct ownership structure in SMAs can offer potential tax advantages, such as enhanced opportunities for tax-loss harvesting.
- Typically, separately managed accounts have higher minimum investment requirements and may incur higher fees compared to mutual funds or ETFs.
- Regulatory bodies, such as the U.S. Securities and Exchange Commission, oversee the operations of investment advisors managing SMAs, requiring detailed reporting to ensure transparency and protect investors.
Interpreting Separately Managed Accounts
Interpreting the value and suitability of separately managed accounts primarily involves assessing their alignment with an investor's specific circumstances and objectives. Because each SMA is tailored, its effectiveness is measured not just by its performance against a benchmark, but by how well it achieves the client's unique goals, such as generating specific income streams, adhering to environmental, social, and governance (ESG) criteria, or managing capital gains. The direct ownership of securities allows for transparent reporting of holdings and transactions, enabling investors to understand precisely what they own. A comprehensive evaluation considers the degree of customization provided, the expertise of the financial advisor or manager, and the overall fee structure in relation to the personalized service received.
Hypothetical Example
Consider an investor, Sarah, who has recently sold a business and has $750,000 to invest. Sarah is in a high tax bracket, holds strong personal beliefs about investing in environmentally responsible companies, and wants to avoid any companies involved in tobacco or firearms. She approaches a financial advisory firm that offers separately managed accounts.
Instead of putting her money into a pooled mutual fund that might contain undesirable companies or distribute unwanted capital gains, the firm helps Sarah open an SMA. Her investment manager then constructs a portfolio of individual stocks and bonds specifically for her. This portfolio is designed to align with her asset allocation preferences, exclude companies she dislikes, and prioritize investments that meet her ESG criteria. Throughout the year, if certain investments within her SMA decline in value, the manager can strategically sell them to realize losses, offsetting gains from other investments, a practice known as tax-loss harvesting. This level of granular control and customization would be difficult, if not impossible, to achieve with a traditional mutual fund.
Practical Applications
Separately managed accounts are primarily utilized by affluent individual investors and institutions seeking highly customized investment solutions. One key application lies in enabling precise diversification and sector exposure. An investor can work with their advisor to construct a portfolio that specifically targets certain industries, geographies, or asset classes, or conversely, to exclude particular holdings. This level of control extends to managing an investor's concentrated positions, such as inherited stock, by integrating them into a broader portfolio strategy while managing associated risks.
Another significant practical application is in tax management. Because investors directly own the securities in an SMA, the investment manager can implement strategies like tax-loss harvesting more efficiently, selling specific losing positions to offset taxable gains. This contrasts with pooled funds where embedded gains from the fund's internal trading activities might be distributed to shareholders, regardless of their individual tax situation. Separately managed accounts are subject to oversight by regulatory bodies like the U.S. Securities and Exchange Commission (SEC), which requires registered investment advisers to provide detailed information about the SMAs they manage, enhancing transparency and investor protection.7 The SEC mandates reporting on Form ADV, requiring advisors to disclose information regarding the types of assets held within SMAs, the use of derivatives, and aggregate borrowings.6
Limitations and Criticisms
Despite their advantages, separately managed accounts come with certain limitations and criticisms. A primary concern for many investors is the typically higher cost structure associated with SMAs. These accounts often involve higher annual advisory fees, sometimes ranging from 1% to 3% of assets under management, which can be considerably higher than the expense ratios of many mutual funds or ETFs.5 While SMAs offer personalized active management, studies suggest that the risk-adjusted returns of SMAs do not consistently outperform other investment vehicles over time, and proactive tax management within SMAs may not always be significantly evident.4
Another limitation is the higher minimum investment required to open an SMA, which can range from tens of thousands to millions of dollars, making them inaccessible to many smaller investors.2, 3 This contrasts with mutual funds or ETFs that often have much lower entry points. While SMAs offer customization, they might also present challenges in achieving the same level of broad diversification as pooled funds that hold hundreds or thousands of different securities.1 Additionally, some investors might find the increased communication and engagement required with a dedicated investment manager, while a benefit to some, to be a drawback compared to the more hands-off approach of pooled investments.
Separately Managed Accounts vs. Mutual Funds
The fundamental distinction between separately managed accounts (SMAs) and mutual funds lies in the ownership of the underlying assets and the level of customization. In a separately managed account, the investor directly owns each individual security within the portfolio. This direct ownership provides the investor with transparency into holdings, control over specific buy/sell decisions (often through granting discretionary authority to an investment manager), and the ability to implement specific tax-management strategies like tax-loss harvesting on individual positions.
Conversely, a mutual fund is a pooled investment vehicle where many investors combine their money. Investors in a mutual fund own shares of the fund itself, not the individual securities held within the fund's portfolio. The fund manager makes investment decisions for the entire pool, and these decisions affect all shareholders uniformly. While mutual funds offer broad diversification and professional management for a relatively low cost, they do not permit the same degree of customization, direct ownership, or individual tax management as separately managed accounts. For example, a mutual fund's trading activity might generate capital gains that are distributed to all shareholders, creating a taxable event even if an individual investor did not sell their fund shares.
FAQs
Who are separately managed accounts typically for?
Separately managed accounts are generally designed for affluent individual investors and institutions who have substantial assets to invest and specific financial goals, tax considerations, or personal preferences that require a highly customized portfolio.
What are the main benefits of a separately managed account?
Key benefits of a separately managed account include direct ownership of securities, enabling greater transparency and control; the ability to customize the investment strategy to align with personal values or specific objectives; and potential tax advantages through strategies like tax-loss harvesting.
How do fees for separately managed accounts compare to mutual funds?
Fees for separately managed accounts are typically higher than those for mutual funds. SMAs often charge an annual advisory fee-based on a percentage of assets under management, sometimes in addition to underlying investment expenses, whereas mutual funds primarily charge expense ratios on their pooled assets.
Do separately managed accounts offer a fiduciary duty?
Yes, investment advisors who manage separately managed accounts generally have a fiduciary duty to act in their clients' best interests. This is a higher legal standard than the suitability standard often applicable to brokerage firms compensated by commission.
Can I include existing investments in a separately managed account?
Yes, in many cases, an investor can transfer existing securities into a separately managed account, allowing the investment manager to integrate those holdings into the overall portfolio management strategy and customize them further. These assets would typically be held in a custodial account under the client's name.