Separately Managed Accounts (SMA)

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Separately managed accounts (SMAs) stand somewhere in between mutual funds and hedge funds. In that sense, an SMA’s minimum initial investment is relatively higher than that of a mutual fund, yet lower enough to overcome the hefty initial requirements of most hedge funds. As a whole, SMAs aim to attract moderately wealthy individuals and institutions.

What Is a Separately Managed Account?

A separately managed account (SMA) is an asset portfolio that is owned by a single retail investor or an institution. Unlike other pooled vehicles, these accounts are not collectivistic, but rather individually oriented. With SMAs, you can benefit from professional portfolio management without sharing your ownership.

Let’s say that you are a high net-worth individual who wants an investment strategy matching specific objectives, portfolio constraints, and tax considerations. In such a case, mutual funds are not what you want because they lack customized portfolio management. However, separately managed accounts (SMAs) overcome this constraint. They represent a portfolio of assets managed by professional investment firms, commonly referred to as registered investment advisors. SMAs are designed exclusively for the benefit of a single individual or institution. Thus, they can be tailored according to an investor’s needs.

When you buy into a mutual fund, you split the ownership of the underlying securities with all investors in the fund. In a separately managed account, you are the actual owner of all the shares. If an SMA portfolio includes the shares of Company A and Company B, the money manager purchases shares in each of these companies on your behalf. In this way, you own the entire account.

Benefits and Drawbacks

With direct ownership comes direct control over your portfolio. That’s the most significant advantage of investing in a separately managed account, because this allows for greater flexibility and transparency of all transactions involved.

Another benefit of SMAs has to do with tax gains and losses. Unlike other pooled vehicles with embedded capital gains, an SMA investor pays the taxes related to their cost basis only.

And most importantly, your portfolio performance depends on you. You do not run the risk of other investors withdrawing their money from the pool and disrupting your fund’s success. Rather, an SMA is specifically driven by your individual objectives.

Separately managed accounts do have a few drawbacks one must consider prior to making an investment decision. The first disadvantage stems from the minimum initial investment. Generally, you must invest at least $100,000 or more to qualify for an SMA. Therefore, large institutional investors and moderately wealthy retail investors are the main users of separately managed accounts.

In addition, an SMA appears to be more time-consuming. An investor must rebalance a portfolio, hold regular meetings with the registered investment advisors, and be actively involved in decision-making. In other words, an individual must spend a considerable amount of time on it. For those who would prefer having a more hand-off portfolio management, mutual funds may be the better option.

Furthermore, managed accounts tend to complete transactions more slowly as compared to mutual funds, though not always. At times, it takes two or more days for a trade to take place because of capital shortage or pending investor consent. On the contrary, mutual funds work fast, where buying and redeeming of assets may easily occur within a day.

What’s more, money managers responsible for an SMA fund charge annual fees for their services. This is much more than the expense fees mutual fund managers typically require. As a result, higher fees could strike portfolio returns. Hence, one should carefully consider the trade-off between customization and profits.

Beyond SMAs

An SMA targets wealthy investors and, although attractive, may not be a feasible alternative option for those with limited capital. Though, it has proven to be extremely effective for the ones who can afford it, due to its customizable nature.

Nowadays, financiers often turn to equities, as an alternative to pooled investment vehicles and separate accounts, by purchasing company shares directly. That’s why we recommend that you read about difference between common stock and preferred stock. Having sufficient knowledge of their characteristics will help you make informed decisions about equity investing.

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