Separately Managed Accounts - What are They?
I'm going to be writing a multi-part series on Separately Managed Accounts, one of the least understood corners of the money management world whose accounts tout a lot of advantages, but in reality suffer from high fees and few tax advantages. Many are simply mutual funds in disguise.
If your account size is big enough, many of the big brokerages like Morgan Stanley, Smith Barney, Prudential, Bank of America - Merrill Lynch offer access to private investment managers through Separately Managed Accounts, aka SMAs. In reality, this option isn’t really different from getting access to the same fund managers via their mutual funds, except that you generally pay a much higher fee.
To understand the difference between SMAs and mutual funds, you first need to understand how the money management world views investors. As a general rule, the industry divides us into a few large groups: small individual investors (which the industry calls “retail investors”) and big investors with tens and hundreds of millions of dollars (called “institutional investors”). Products designed for retail investors – again that includes most of us -- have low minimum account sizes, like the retail classes of mutual funds. On the other end, where the big institutions play (which include university endowments and large pension funds), there are products that impose minimum requirements of $25 million or more. In between these two is the universe of separately managed accounts (SMAs) targeted at wealthy (but not necessarily ultra-wealthy) individual investors. Here you can usually get started with $50,000-$100,000.
Defining Managed Separate Accounts
A separately managed account is a portfolio of assets managed by a portfolio manager at an investment firm. One or more portfolio managers are responsible for day-to-day investment decisions, supported by a team of traders, analysts, operations and administrative staff. SMAs differ from mutual funds in that each portfolio is unique to a single account (hence the name). In other words, if you set up a separate account with Money Manager X, then Manager X has discretion to make decisions for this account that may be different from decisions made for other accounts. In contrast, mutual funds are portfolios where all investors pool their money and the portfolio manager invests the fund as one account, so each investor gets the identical portfolio.
So, for example, say that a portfolio manager manages a portfolio of 30 stocks. The manager can launch a mutual fund containing these stocks and also an SMA product. At the beginning, the manager usually invests all portfolios the same way, buying stocks in the same percentage - for both the mutual fund and the SMAs. But then things begin to diverge. The decisions the manager makes for the mutual fund - including the timing for purchase and sale of shares, dividend reinvestment and distributions - will affect all fund investors in the same way. For SMAs, however, the decisions are at the account level and will therefore vary from one investor to another….in theory. In practice, most SMA accounts are invested identically.
Mass Customization
The selling point is that an investor can “customize” her individual account giving her a greater degree of control over investment decisions. Some investors even have investment policy statements that formally outline their individual objectives and constraints. The limited ability to tell the portfolio manager what to buy and sell has some benefit at tax time. Investors can take losses for example to apply against gains in other accounts.
All this sounds great, doesn’t it. Well, SMAs are not worth the price in the vast majority of cases. Read my blog on Separately Managed Accounts – What They Won’t Tell You for more.
