What Is SMA in Investing?

By: Victoria Lee Blackstone | Reviewed by: Ashley Donohoe, MBA | Updated May 17, 2019

In the world of investing, separately managed accounts (SMAs) typically attract a sweet spot of investors who are bigger players than middle-income investors but smaller players than multi-million-dollar institutional investors. This middle investor category generally finds itself populated by wealthy investors who like the flexibility and greater control that SMAs offer them. Although SMA investments are managed by professionals, individual investors actually own the securities in their funds instead of pooling their resources in commingled funds.

Tip

According to the U.S. Securities and Exchange Commission (SEC), "a 'Separately Managed Account' or 'SMA' is a private portfolio of actively managed individual securities."

What Is an SMA Account?

An SMA account, which is managed by a professional financial manager or asset management firm, is a portfolio that may include different types of investments such as stocks, bonds, individual securities and cash. This portfolio is private, which means the assets it contains are not commingled with other investors, and it is separately managed. Its separate status allows an SMA manager to customize the portfolio according to its investor’s goals and preferences. SMA investors own all the securities in the account, and they directly negotiate the fees with the account manager.

SMA and Mutual Funds Difference

Pooled investment accounts, such as mutual funds, do not allow the customization that SMAs offer their owners. When you invest in a mutual fund, your assets are combined with those of other investors who invest in the same fund. But when you invest in an SMA, your funds are in a separate portfolio that is uniquely yours. This means that your asset manager tailors your investment as a customized portfolio for you as an individual instead of managing a blended portfolio for a group of investors, which defines the structure of mutual funds and exchange-traded funds.

SMA Customization Benefits

Other than the benefit of flexibility in custom-tailoring an SMA account to an investor’s specific preferences and goals, SMAs also allows investors to control their investing decisions. For example, someone who wants to invest only in a certain market sector, such as the green industry, can direct the account manager to channel funds in this direction. And, likewise, an investor who strongly wishes not to invest in a certain market sector, such as a tobacco company, can steer clear of undesirable investments.

Investors who need to avoid conflicts of interest with their investment choices in certain companies or certain industries can cherry-pick which investments they want to be omitted from their SMA portfolios. Investors in mutual funds cannot do this.

Investments carry fees and tax implications. Investors in mutual funds join other investors with a pool of investment funds, the fees of which are also commingled for the “greater good,” so to speak. This means that individual investors in a pooled fund cannot exert control over the investment decisions. But SMA investors directly influence how fees are spent.

SMA Transparency Benefit

When you invest in an SMA account, you’ll be able to see exactly which securities you own, which is a feature that’s not always apparent if you invest in mutual funds. And you’ll also be able to watch trading activity with SMA investments in real-time instead of learning about it after the fact, which is characteristic of mutual funds. This insight and transparent bird’s-eye view of SMA holdings and transactions are what give you the facility to control your own investment decisions.

SMA Tax Efficiency Benefit

If you invest in mutual funds, you know that capital gains tax is a shared liability that's imposed on all the investors in a fund. But if you invest in SMAs, you’ll only be taxed on your personal portfolio’s realized gains. And since your SMA is composed of individual securities, you can offset capital gains tax by selling investments through a process called tax-loss harvesting.

Tax Loss Harvesting

Tax-loss “harvesting” is the practice of selling certain securities to minimize or eliminate your capital gains liability. Typically, tax-loss harvesting is directed at short-term capital gains, because you pay more tax on short-term capital gains than long-term capital gains. And since higher-income investors are the SMA demographic, they represent a tax-sensitive group that seeks to minimize capital gains tax wherever they find opportunities.

If, for example, you have two securities in your SMA portfolio that you purchased at similar prices, but the value of one has increased two-fold while the value of the other has fallen to half its purchase price. If you direct your asset manager to sell both of these securities, the capital gain of the one with the two-fold value will be offset by the capital loss of the security that’s now half-value, effectively netting you no capital gains tax. But then you can turn around and reinvest the proceeds from the securities’ sales, keeping the investment balance in your SMA.

No Embedded Capital Gains Benefit

Because mutual funds carry a shared tax liability on capital gains, and these capital gains are only paid once per year, some of the gains are actually embedded in the portfolio. For example, you may buy into a mutual funds portion in December without receiving any capital gains the fund produced between January and November. But you will incur the capital gains liability because these gains were embedded in the portfolio during the same tax year that you invested in it … even though you didn’t become an investor until December. If, however, you invest in an SMA, you are not tax-liable for any capital gains before the day that you invest in your portfolio.

The Price of Investment

You may imagine that you’ll need to be a high-dollar investor to invest in an SMA, and generally, you’re right. But many asset-management firms have significantly lowered their “price of admission” SMA investing threshold, which has historically been $1 million. You can find investing firms that have lowered this bar to $100,000, opening the gates for many investors who couldn’t previously touch an SMA without ponying up $1 million.

If you’re a retail investor with a high net worth, an asset-management firm may set a higher minimum balance, somewhere between $100,000 and $5 million. And if you’re a high-dollar institutional player, plan on a minimum account size between $10 million and $100 million.

SMA Fee Structure

Fees for an SMA are structured differently than the fees for a mutual fund. Mutual fund fees follow a certain structure based, in part, on the net expense ratio. Typical fees include the management fee, sales charges and certain expenses. These fees must be disclosed in a company’s prospectus, which establishes the fees and publishes examples of how the fees translate into dollar amounts over certain holding periods.

In contrast, SMA fees are determined between an asset manager and an individual investor. These fees are listed in a regulatory document (Form ADV) instead of being published in a prospectus. This fee schedule is negotiable, which is why you may not be able to download it as you can for a mutual fund prospectus. Another departure from mutual fund fees is that an SMA’s fee may be calculated on an incentivized scale in which the fee decreases as an investor’s volume of assets increases.

SMA's Form ADV

The SEC requires professional investment advisors to submit Form ADV (Uniform Application for Investment Adviser Registration and Report by Exempt Reporting Adviser) as a registration document for securities. Form ADV includes the names of key investment officers/advisors, investment styles and investment strategies, among other disclosure information for the investment firm.

Asset managers should freely offer Form ADV to any potential investors, and you may view it as a bit of a red flag if it’s not offered to you even after you request it. Financial firms must update Form ADV with any material changes to the firm that impact their business.

Two Types of SMAs

There are two general types of SMAs – single style, with lower investing thresholds, and multiple style, with higher investing thresholds. Asset managers work with investors to determine which SMA type is the best fit, not only based on their investment amounts but also on their risk tolerance preferences and investment objectives.

Although investment minimums vary among asset managers, and $100,000 is a typical low threshold, a single style SMA may allow investors in with as little as $50,000 for equity portfolios. Fixed-income portfolios typically require a higher minimum, which is usually $100,000. Single style SMAs are structured with a distinct style of investing in mind.

A multiple style SMA, however, is structured with a diverse investment style in mind. This type of SMA represents a diversified portfolio with investments across different asset classes and even among different managers, although one manager oversees all the investments. The minimum investment typically is $100,000 to $300,000.

SMA Performance Data Composite

Savvy investors want to see performance data of a potential SMA before investing in it. This data should include annual and quarterly returns of the SMA, which is compiled in a composite. The composite is typically organized into a table that shows the aggregate performance of all the fee-paying accounts in the SMA. Other than this at-a-glance review, investors may also want to find out if a third-party auditor (not an in-house auditor) has affirmed the SMA’s compliance with the Global Investment Performance Standards.

These standards are established by CFA Institute, an international organization comprised of more than 70,000 members who have earned the Chartered Financial Analyst (CFA) designation. This organization provides an ethical benchmark for promoting the high standards of conduct and behavior required of investment professionals.

New SMA Reporting Information

In August 2016, the SEC mandated a new SMA reporting amendment (with compliance required by Oct. 1, 2017). Part of this amendment increased the required reporting information to include more comprehensive data, including the types of assets held in SMAs, the use of borrowing and derivatives (for firms with regulatory assets under management in excess of $500 million) and the role of custodians.

Twelve SMA Categories

This same 2016 amendment required investment advisors to identify SMA assets into one of 12 categories:

  1. Exchange-traded equity securities
  2. Non-exchange traded equity securities
  3. U.S. government bonds
  4. U.S. state and local bonds
  5. Sovereign bonds
  6. Corporate bonds (investment grade)
  7. Corporate bonds (non-investment grade)
  8. Derivatives
  9. Registered investment companies and business development companies
  10. Pooled investment vehicle securities
  11. Cash and cash equivalents
  12. Other

SMA Due Diligence

When considering an SMA for a potential investment, you will ideally work with an investment professional who has a similar investment philosophy, style, risk-tolerant focus and approach to investing as you do. Don’t be hesitant to ask questions so that you can evaluate a manager, in addition to reviewing the firm’s ADV. After determining that a manager’s philosophy closely aligns with your own, ask questions about the firm itself – how decisions are implemented, how often the investment committee meets and even how the firm pays its professionals.

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About the Author

Victoria Lee Blackstone was formerly with Freddie Mac’s mortgage acquisition department, where she funded multi-million-dollar loan pools for primary lending institutions, worked on a mortgage fraud task force and wrote the convertible ARM section of the company’s policies and procedures manual. Currently, Blackstone is a professional writer with expertise in the fields of mortgage, finance, budgeting and tax. She is the author of more than 2,000 published works for newspapers, magazines, online publications and individual clients.

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