Improvements in SMA tech have more advisors getting on board

A new Goldman Sachs survey shows investors are big fans of separately managed accounts. But what do advisors think of them? Are they worth the trouble for all their clients, or just a lucky few?

“I have used SMAs and found them to be very beneficial due to several factors, such as the ability to leverage professional management and customization to individual preferences and objectives, direct ownership, and transparency for clients to see the specific securities held within, and the ability to offer tax efficiency through tax-loss harvesting, and of course a method of diversification to complement their core investment strategies,” said Chris Mankoff, certified financial planner at JTL Wealth Partners.

Scott Bishop, certified financial planner at Presidio Wealth Planners, said he used SMAs often when they first came to prominence in the late 1990s as a way to have more customized portfolio management with better tax efficiency. Nevertheless, he found that after fees and limitations, the accounts tended to be “more sizzle than steak.”

However, given technology gains in recent years, SMAs and even direct indexing have become more affordable and easier to use. 

Direct indexing is basically the next level of SMAs because it leverages emerging technologies to customize just about any index to meet an investor’s specific needs, whether that involves tax management, ESG preferences or even to navigate around overweighted exposure to specific stocks.

“They allow us to do tax-loss harvesting and avoid stocks where a client may be overweight already, such as employer stocks or other low-basis holdings,” Bishop said. “It’s so much easier now with the new computer programs and you don’t need one account for each SMA anymore.”

He added that one downside to consider in international SMAs versus mutual funds is that international SMAs usually can only hold international stocks traded on U.S. stock exchanges. As a result, investors may miss out on certain stocks that could be held in funds.

Bishop also said that for smaller clients, or clients with mostly pretax money, he tends not to use SMAs because of “rebalancing complexity and no need for tax efficiency.”

The RIA world’s big hitters have been getting on board in a big way.

In 2021, AssetMark Financial introduced a dozen SMA strategies in hopes that it would give advisers more personalized portfolio options for their clients. A year later, LPL Financial made a big splash rolling out its SMA strategies as an investment option within its Model Wealth Portfolios. Meanwhile, Morningstar announced last November its intent to build on its $12 billion separately managed account platform with the addition of a direct indexing feature aimed at the financial advisory market.

Aron Kershner, managing director at Goldman Sachs, underscores the fact that there’s no one-size-fits-all approach to SMA investing, primarily because there are so many applications and use cases. He said SMAs are especially effective for “outcome oriented” investors with charitable intent, those who are trying to transition out of an underperforming equity manager or those sitting on a concentrated stock position, which is a very familiar scenario for Kershner.

“Our first approach is to work closely with the advisor and provide analytics on the portfolio, whether it’s a few names or a few hundred names, anywhere in between. We outline the risk, the concentration, the sector imbalances, and then we offer solutions on how to diversify and absorb the positions in a really tax-thoughtful manner,” he said. “We built digital tooling that provides advisors multiple diversification scenarios so that they can choose the right solution for each client based on risk reduction.”

Investors who have concentrated positions in illiquid holdings, as many entrepreneurs do, should consider reducing highly correlated positions from their public equity portfolio, Kershner said. For example, an employee at a big tech company might choose to divest from the technology sector in their large cap portfolio.

“Direct indexing allows you to customize that market exposure, and then you can use tax losses to help reduce concentration in really tax balanced way,” he said.