Tax Benefits of Separately Managed Accounts

A separately managed account (SMA) is a portfolio of securities you can invest in. It’s similar to an ETF or mutual fund. However, when you invest in a SMA, you own all the securities within your portfolio. This gives you a bit more flexibility as to how those funds are invested and managed, as well as the transparency to monitor trades in real-time.

SMAs are managed by professional money managers. Fees may be higher than those associated with mutual funds, but it may be the case of you get what you pay for. For example, you may have more involved management and flexibility when it comes to your investments.

That’s why SMAs are managed by investment professionals and designed for high-net-worth (HNW) individuals who have specialized or sophisticated needs and seek bespoke investment solutions.

Why SMAs are so popular?

SMAs were developed in the 1970s for investors who had an investment objective that mutual funds at the time couldn’t help them pursue. Innovation in mutual fund variety really didn’t take off until the 1980s and 1990s, when funds became the standard investment choices of defined contribution retirement plans. Investors who were looking for something more than a plain-vanilla fund had to either manage their own portfolio of individual securities or give that management responsibility to a professional asset manager.

That’s where SMAs came in. Typically starting with a blueprint of an existing strategy, the SMA could be fine-tuned to the investor’s needs and then professionally managed by the asset manager. The typical buyer in those early days was an institutional investor, but that’s changed. 

Through 2023, SMA assets under management had climbed to nearly $2.2 trillion, while managed accounts as a whole—including mutual fund advisory, ETF advisory, and unified managed accounts—were roughly $11.5 trillion. The projected growth rate for the managed account industry was 13.1% annually through the end of 2026.

Benefits of SMAs

Flexibility—SMAs have more flexibility than mutual funds or ETFs because SMAs aren't governed by a prospectus. Typically, a prospectus limits a fund’s strategy to operating within certain guidelines. For example, mutual funds have restrictions on how much of a company’s shares they can own and must meet certain security and sector-exposure requirements to be considered diversified. SMAs are different in that they can have far fewer holdings than a fund and investors can modify an off-the-shelf strategy to suit their needs. While SMAs aren't governed by prospectus, the registered investment advisors who offer them are required to provide investors with an ADV brochure (named after the Securities and Exchange Commission's Form ADV) that outlines information about the advisory firm, fees, services, and the like.

Transparency—Mutual funds are required to list their complete holdings each month on a publicly available website, but these listings typically post after a delay of 30 to 60 days, with a fund’s 10-largest holdings displayed sooner. ETFs are required to list holdings daily. Because SMA investors own the underlying portfolio holdings directly, they can view those positions at any time. SMAs also typically detail fees and performance separately on a quarterly basis, offering a clear view of the investment’s ongoing expense.

Lower fees—Fees are generally lower for SMAs than for actively managed mutual funds, in part because SMAs aren't responsible for all the regulatory reporting and administration associated with funds. How much lower? According to Cerulli Associates, SMA management fees range from 0.19% to 0.40%, with a median fee of 0.24% for fixed-income SMAs and 0.34% for equity SMAs. This compares to an average fee of 0.52% for an actively managed mutual fund. It’s important to remember that a financial professional’s fee, often 1.00% of account assets, will be added to the management fee of the underlying investment.2

More opportunity for Tax loss harvesting

Depending on the investment strategy of the SMA—most focus on different asset classes of stocks or bonds—investment managers can apply a range of personalized tax-smart investment techniques in an effort to increase after-tax returns.* One popular technique is tax-loss harvesting, a method for reducing how much will be owed in capital gains tax by selling holdings that are losing money and buying a replacement security. This strategy is frequently used to offset taxable realized capital gains in the current or future years. Net result: Less money goes to taxes and more stays invested.

While effective tax-smart management techniques can be applied to portfolios composed of mutual funds and/or ETFs, SMAs offer investment managers more opportunity for tax-loss harvesting because SMAs typically include a large number of individual holdings. This allows for tax-loss harvesting opportunities depending on a customer's specific situation.

For example, if stock XYZ in a mutual fund or in an ETF suffers a significant loss, a client is not able to sell off stock XYZ from the fund to realize a loss on it. With SMAs, the client owns the specific securities. A portfolio manager who supports the client can systematically identify and sell just XYZ stock to take advantage of the potential tax savings if they have realized gains elsewhere in their portfolio or to offset income. XYZ stock would then be replaced with a similar security to maintain the appropriate exposure for the strategy.

Ability to avoid capital gains distributions

Another tax advantage that comes with SMAs is the ability to avoid capital gains distributions, a common concern with mutual funds, and to a lesser degree, ETFs. With a mutual fund or ETF, all shareholders are hit with the tax liability on the capital gains incurred by the fund, which must be distributed annually.

For example, investors purchasing shares of a fund in December will not benefit from any price appreciation the fund has had during the year. However, they may still receive a distribution if the fund has capital gains to distribute and if their purchases are prior to the distribution date. Once received, they will have a tax liability for that year. However, if those same investors bought an SMA, they will only have a potential tax liability when the individual securities they own are sold. This gives them a more direct link with their capital gains and tax obligations. These investors may also have the ability to fund their SMA with securities they already own, which can help reduce any tax impact as they transition into the portfolio.

What's right for you?

Separately managed accounts are not for everyone. But if you like owning individual stocks or bonds, and you're looking for a customized portfolio and tax-smart strategies, they may be worth considering. As always, it's important to align your strategy with your personal objectives, financial situation, and risk tolerance.