Does your retirement plan offer Separately Managed Accounts (otherwise known as “SMAs”)? According to a recent report by Cerulli Associates, SMAs may represent the next big trend in 401k plans. Are you ready for it?
Why might 401k plans want to offer SMA options on their investment menus?
“Many financial providers have adopted the fiduciary business model, and many clients, especially retirement investors, have come to expect that their advisers are acting in their best interest, free from conflicts of interest,” says Michelle Capezza, Of Counsel at Mintz in New York City. “Moreover, with trillions of dollars invested in retirement plans, many investors desire rollover recommendations from advisers that will act with a fiduciary standard of care.”
But there’s a business model downside to this industry-wide trend towards acting as a fiduciary.
“Everyone is now offering a fiduciary model,” says Andy Larson, Director of Retirement Education at Retirement Learning Center in Brainerd, Minnesota. “It is now seen as a commodity. Plan committees are getting more effective in oversight and vetting.”
Service providers who put themselves out as fiduciaries used to have a competitive advantage. With everyone now doing it, that advantage has evaporated. Today, financial professionals must search for business model alternatives that take “fiduciary” to the next level.
Cerulli’s report says by focusing on SMAs, investment advisers can do precisely that. Not all veteran professionals agree. Still, with a growing number of 401(k) plans beginning to offer SMAs, perhaps it’s time for you to gain a greater understanding of what they are.
What are separately managed accounts?
SMAs represent a way for investors to escape the “one-size-fits-all” world of mutual funds, ETFs, and other commingled investment products. It’s a chance to move away from big-box financial firms and receive customized service from smaller boutique individual advisers (even ones that work for larger firms).
“Consumers/Investors are dying to have a new experience,” says Richard Bavetz, investment advisor at Carington Financial in Westlake Village, California. “The dominance of big brokerage firms & wirehouses has given the average investor the impression that there’s no alternative or that their choices have been limited and to switch wouldn’t make any difference in the outcome. The fiduciary model offers investors the alternative approach they’ve been seeking.”
What is the purpose of separately managed accounts?
Unlike mutual funds, where you invest in a shared basket of securities along with thousands of other investors, SMAs represent portfolios of individual stocks and bonds tailored to your specific needs. Created by personal investment advisers, no two SMAs are alike.
At least in theory. People with similar needs and circumstances can have similar portfolios if each portfolio begins simultaneously. While this may sound like a “cookie-cutter” shortcut, there are compliance reasons investment advisers need to make sure portfolios in these specific circumstances don’t vary too widely.
The greater point is you should expect your SMA to be highly personalized.
“Separately managed accounts offer customization of investments for an account,” says Capezza. “The investments can differ for each investor. These actively managed accounts have their own fee structures that are more expensive than investing in mutual funds. Typically, these accounts require a minimum investment of $100,000. Managed accounts can also be a feature for a retirement plan and can offer active management of a retirement account.”
What is a major advantage of a separately managed account?
Why go through the trouble and added expense to adopt an SMA approach to your investments? The key is SMAs more accurately match your investments with your goals and liabilities. This gives you a better chance to achieve the former and avoid the latter.
“Investors get access to direct ownership of their investments (e.g., individual stocks and bonds),” says Bavetz. “Transaction costs generated by other investor behavior, namely panicked sell-offs or end-of-year sell-offs by fund managers, can be drastically reduced or eliminated. SMAs also reduce costs generated by embedded cap gains in non-qualified accounts populated by mutual funds. Even further, tax loss harvesting strategies can and indeed do add value to the net performance of non-qualified accounts held on SMA platforms.”
What is a major disadvantage of a separately managed account?
Mind you, SMAs do have a downside. You’ll need to weigh the costs and benefits before deciding to use them. There are a couple of key disadvantages to focus on.
“The first is cost,” says Larson. “A good SMA will cost more. Another disadvantage is that all SMAs are not created equal. Some SMAs don’t use enough or appropriate date points to provide real value.”
With the popularity of default investments and the feeling you can take a “set-it-and-forget-it” approach with your 401k, it’s critical you recognize SMAs are very hands-on.
“You need to understand that even if you use an outside investment manager, you still need to review and understand what the investment manager is doing,” says Bob Lowe, partner through his professional corporation at Mitchell Silberberg & Knupp LLP in Los Angeles, California. “Appointment of the investment manager is a fiduciary act, so you need to review the fiduciary’s actions to make sure that the appointment was reasonable.”
What is the minimum account size of a separately managed account?
Lastly, SMAs aren’t for everyone. You’ll need to have a critical mass of savings before you can qualify to use one. More significantly, the real power of SMAs may not be seen until you have a much higher level of assets.
“$100,000-150,000 is generally the minimum asset size as a step up from mutual funds or ETFs, although the significance of an SMA’s benefits really kicks in at $350,000-500,000,” says Bavetz. “Because each strategy or ‘sleeve’ will have a minimum on its own, an investor’s portfolio will usually need to have enough investable assets to be spread across the different strategies to get the necessary allocations and diversification for that particular investor. These types of asset strategies were formerly only available to investors with many millions of dollars, so it is a distinct departure from what the average investor is used to and is surely a welcomed breath of fresh air.”
Has this piqued your interest in SMAs? If so, talk to your retirement plan administrator to see if your plan offers SMAs and if you meet the minimum requirements necessary to use them.