Once reserved for institutional investors and ultra-high-net-worth clients, separately managed accounts (SMAs) are growing ever more popular in U.S. wealth management portfolios. Mutual funds have been advisors’ vehicle of choice for wealth management clients historically, and exchange-traded funds (ETFs) continue to grow. Yet advisors are also increasingly turning to SMAs, which allow for more customized investment solutions for clients and help advisors differentiate their product offerings in an increasingly competitive market. The strong growth in SMAs in recent years (see Figure 1) is likely no coincidence: Many characteristics of SMAs would particularly resonate with investors who witnessed the volatility of 2008.

In this Q&A, Eric Mogelof, PIMCO’s head of U.S. global wealth management, Mark Thomas, PIMCO’s head of SMA solutions, and Alan Trice, head of advisory services for Gurtin Municipal Bond Management (a PIMCO company), discuss the ongoing evolution of SMA strategies and how they may be used to advantage in portfolio construction.

Q: What are SMAs, and how are they different from mutual funds and ETFs?

A: A separately managed account (SMA) is an investment account in which an individual holds individual securities directly in his or her own name. This is opposed to owning shares of a commingled investment in a fund company, as with a mutual fund or ETF.

While fee structures for SMAs may vary, they are typically asset-based and generally provide a competitive fee structure for large investors relative to mutual funds.

Q: What are the key potential benefits of SMAs for investors?

A: The key benefits of SMAs for investors boil down to customization and control of their investment solutions in seeking to meet specific portfolio needs. For example, a municipal SMA investor could express state preferences, set a target yield, and limit duration and sector exposures. Customization could also include adding an ESG (environmental, social, and governance) or SRI (socially responsible investing) investment overlay.

Particularly relevant to fixed income, SMAs enable investors to hold securities to maturity and choose to weather any mark-to-market price volatility in a way that commingled vehicles do not. And because investors own the securities directly, they have the freedom to change managers without being forced to sell securities. The securities’ portability gives investors the freedom to change custodians or trust structures, or to gift the securities.

This level of control also enables investors to manage their personal tax consequences. An SMA investor can decide which tax lots are the most favorable to sell from a tax perspective to meet liquidity needs. SMAs also allow for tax-loss harvesting, as individual positions may be sold to realize losses to help reduce tax bills.

In short, SMAs provide investors the flexibility to customize their portfolios to meet their specific needs. Tax considerations, credit risk tolerance, and time horizons are among many variables that investors may seek to optimize. And despite their high level of specification, SMAs often come with fees that are highly competitive relative to traditional mutual funds.

Q: What are some potential drawbacks?

A: No investment vehicle will be optimal for all investors, and while SMAs are often an attractive vehicle for larger investors, there are drawbacks. SMAs typically have high minimum investments, generally between $150,000 and $5 million. And even with high minimums, most SMAs will not be as diversified as the typical mutual fund.

Determining the appropriate vehicle for a given strategy is a critical decision for advisors to make with each client. Liquidity, for example, is a key consideration. In fixed income accounts, for instance, transaction costs typically decline as position size increases; smaller positions may be more costly to trade and could become illiquid during periods of stress. Additionally, it may take additional time to sell individual securities (for example, some municipal bonds may be thinly traded), and settlement may take longer relative to mutual funds.

Ultimately, SMAs may be more appropriate for investors with limited liquidity needs or who expect will only need to draw income from their accounts.

Q: Why do advisors like using SMAs in portfolio construction?

A: Advisors like SMAs for all of the reasons individual investors do, and primarily because they offer the flexibility to tailor portfolios to their clients’ individual objectives. In addition, SMAs can help advisors keep total costs down (e.g., by aggregating client accounts with a professional manager) and can provide added transparency into their clients’ portfolios. The added level of customization at the individual security level may also help manage tax-related decisions.

Increasingly, advisors are outsourcing SMAs to professional managers with the ability to combine a consistent investment approach with the tools to customize portfolios at competitive fees. This may provide an advantage by freeing up time for advisors to spend with clients to focus on financial planning.   

Lower turnover is another potential benefit. In our experience, clients and advisors hold their SMA positions longer than mutual fund or ETF vehicles.

Q: How are advisors using SMAs in portfolio construction? What strategies make sense in the SMA vehicle, and which strategies do not?

A: While advisors traditionally have utilized SMAs for equity allocations, they are increasingly using these vehicles for fixed income allocations, particularly in tax-exempt municipal bonds. We’ve observed that advisors are tapping SMAs to provide tax advantages to clients, and in fixed income accounts where there is a desire to hold bonds in certain strategies to maturity. Advisors who historically built portfolios of individual bonds or relied on their trading desks to source bonds may find professionally managed SMAs increasingly appealing. The migration to fee-based platforms, along with regulatory changes, have also raised interest in SMAs, again particularly for munis.

Strategies that may not be suitable for SMAs include those that have high turnover, require significant levels of portfolio diversification, or are held by investors for short periods of time. Those that use derivatives or other complex assets also may not be good candidates.

Q: What factors should an advisor consider when selecting an SMA investment manager?

A: We believe advisors should work with managers who share their investment philosophy and offer strategies that align with their clients’ goals. Scale and operational expertise are also important, as is market access. In fixed income especially, efficiency and investment research are equally important to drive returns and manage risk.

Client experience is critical in SMA management given the transparency, additional operational complexities, and unique characteristics of each individual’s portfolio. A firm with an experienced and client-centric service culture can help guide clients through any headaches and help enable the vehicle’s benefits to be realized. For example, detailed and customized reporting helps to inform clients and advisors about the makeup and outcome of their investments.

Q: What are unified managed accounts (UMAs), and how do they differ from SMAs?

A: Unified managed accounts allow advisors to offer clients multiple strategies and vehicles in one account. The growth of UMAs has played a big part in the resurgence of SMAs. The ability to invest in a goal-based or outcome-oriented diversified portfolio across vehicles allows an advisor to select what they believe to be the right product in the right structure to help meet clients’ objectives. As discussed, selecting the right vehicle is almost as important as selecting the right strategy. UMAs provide freedom to use mutual funds, ETFs, and SMAs based on the client’s profile and holding period/liquidity needs, the complexity of the strategy, and other factors.

Q: How is PIMCO approaching SMA solutions for wealth management clients?

A: At PIMCO, we partner closely with financial advisors to help them deliver the right strategy in the right vehicle for their clients. We have invested heavily in portfolio management resources and technology to enable advisors to take full advantage of the SMA vehicle. From onboarding to customization to reporting, we focus heavily on helping financial advisors deliver unique, differentiated solutions to their clients.

For investors focused on income, lower turnover, and competitive fees, we have a suite of both corporate and municipal laddered solutions. And for investors with differing objectives – such as higher income or lower volatility – we offer several strategies specifically designed to meet them. Finally, we offer a variety of SMAs focused on the goal of delivering above-benchmark returns: Our Total Return, Real Return, Low Duration, and Municipal Bond strategies leverage proprietary commingled vehicles for less than half the portfolio alongside the core segment of individual bonds to provide diversification and access to a wide variety of markets.

There is no one-size-fits-all strategy, and we believe advisors should work with each client to develop a plan tailored to their specific goals and objectives. In many cases, SMAs may be an integral piece of the full investment strategies that advisors curate for their clients.

Test out scenarios for a muni ladder SMA portfolio with our interactive Muni Ladder Portfolio Calculator.