The rise and rise of SMAs

There is nothing new under the sun. It’s a sentiment expressed in the investment world when worldly, seasoned professionals hear over-enthusiastic folk sprout something along the lines of It’s different this time, revolutionary, it’ll change your world!

It recalls legendary chair of the United States Federal Reserve, Paul Volcker’s brutal quip that the ATM was the last useful financial innovation!

It’s dicey to disagree with icons but we would argue that Separately Managed Accounts (SMAs) deserve recognition as a useful financial innovation too. Frankly, the descriptor “useful” undersells SMAs, and belies their meteoric rise.

They have been a boon for financial advisers freeing up time for pursuits like deepening client relationships and understanding, as well growing their businesses, while delivering for investors institutional-quality portfolios, transparency, and forensic communication.

Returning to our opening There is nothing new under the sun: SMAs can rightfully be regarded as an evolution of investment platforms because they share some of the benefits of master trusts and wraps, like ease of reporting and efficiency, while providing investors with additional benefits, arguably the most notable being that investors have beneficial ownership of the underlying investments, and efficient adjustments of model portfolio positionings.

While talking up the benefits and advantages of SMAs, we are determined to avoid the investment industry’s tendency to present these types of situations in zero-sum ways. Think passive versus active, small caps versus large caps, growth style investing versus value style investing, public versus private assets, and on it goes.

You can add SMAs versus pooled managed investments to the zero-sum list.

There is no reason to put down pooled managed investments while talking up SMAs. Pooled managed investments have been a terrific way for generations of Australians to grow their long-term wealth, especially through superannuation.

That being the case, we think it is constructive to examine the benefits of SMAs, particularly given their rapid take up and growth over recent years.
 

Beneficial asset ownership

Let’s kick off with the principles of customisation and personalisation. The ability to increasingly have experiences crafted to suit our personal preferences is something most of us appreciate about contemporary life.

This desire helps to explain the success of streaming services, a multitude of apps, playlists on phones, and so much more. These all bring strong elements of transparency, flexibility, and efficiency for the individual.

So, consumers rightly ask, why not in investments too? SMAs are one solution for this consumer desire for personalisation, in our view.

While SMAs may comprise individual pooled funds, there is a decomposition of underlying assets within asset and sub-asset classes, and in some cases down to the individual security level. At the model portfolio level, investors benefically own assets because their headline fund investment is not pooled with those of other investors.

Instead, in an SMA, an investor is the beneficial owner of the managed investments, shares, exchange-traded, and other assets held within their account. Moreover the investor can easily see exactly what securities they hold; are able to monitor performance daily, if they desire; and can adjust, add or exit their positions effortlessly, enabled by what is ultimately a technology solution.

In other words, they have control and full sight of the details of all their investments.
 

Potential tax advantages

SMAs can also provide potentially significant tax advantages because they overcome a problem inherent in pooled managed funds where capital gains tax liabilities of all unitholders are shared.

By contrast, in a well constructed suite of SMA model portfolios, an investor can move between portfolios efficiently, on the back of a commonality of underlying components. All this can be accomplished without the burden of triggering significant tax realisation events.

It’s useful to unpack potential benefits a little more.

As pooled managed investments are collectively owned through a fund, all investors share the tax liability on the capital gains incurred by the fund, which are typically paid out once a year.

Say, for example, a fund doubled in value from January through November, investors buying into the fund in December would not get the benefit of the gain, but instead inherit a potential tax liability because the realised and unrealised capital gains are naturally embedded in the portfolio.

By contrast, in a SMA, because of the individual control of underlying assets, and deconstructed underlying investment building blocks, the investor would likely not be liable to anywhere near the same extent for capital gains generated prior to the day they invested in the portfolio.

Direct Australian listed shares within an SMA model portfolio would further amplify this consideration, in our view.¹

Furthermore, the investor can make in-specie transfers of assets in both directions, meaning they can potentially combine direct shares they may already own, outside the SMA, with those inside the SMA, without having to sell and repurchase those assets.

Liberating financial planners by putting greater day-to-day onus on investment managers

SMAs also mean that the day-to-day management of investments are taken care of by a professional investment manager reviewing and adjusting model portfolio allocations, and by the SMA provider rebalancing the investments periodically or in response to a change by the investment manager.

This liberates the adviser from the role of investment manager and administrator for every portfolio change or corporate action.

Platform technology, combined with investment manager insights, and clear, effective communication combine to empower deeper engagement and understanding of client needs, which in some (arguably many) cases, reside outside of the underlying investment program.

By having the investment manager and SMA provider take responsibility for all aspects of the investment, including day-to-day portfolio monitoring, repositioning, and administration, financial advisers are freed from having to carry out rebalancing, which can be time-sapping when multipled across many clients of differing cohorts.

Doing so also unburdens financial advisers from needing to provide records or statements of advice every time client portfolios are changed.

The corollary of the above is that SMAs represent a highly scalable and efficient investment business solution as they enable advisers to control and manage portfolios for many clients, consistently and equitably.

Arguably, this reduces pressure on the adviser’s back office and settlements team potentially enabling these resources to be redeployed to deepen client engagement, business growth and revenue-generating activities.
 

A next frontier – less liquid assets and strategies

SMAs are the proverbial ‘overnight success’ that’s been a couple of decades in the making, but they are far from the finished article.

The requirement for daily-priced funds, on platforms, makes it more difficult to integrate private market opportunities like private equity, unlisted infrastructure, and alternative strategies, like private credit.

Private market assets and strategies, complementing public asset investments, have been features of institutional portfolios for many years and increasingly figure in the retail pooled investment world.

Integrating such assets and strategies in SMAs represent a next frontier, challenge and opportunity, we believe.

For now, investment managers, like us, have developed ways of bringing private assets into SMAs by having them as components of alternative strategies, for example, which we believe provides diversification benefits by accessing different types of investment risks and return opportunities.

However, these ‘workarounds’ do mean that the investor does not have beneficial ownership of such less liquid underlying assets, typically a major benefit of managed accounts.

That said, given the wealth industry’s long history of innovation, it’s conceivable that the private assets challenge in SMAs will eventually be overcome enabling these types of diversifying investments to find their ways into model portfolios.

No ceiling on SMA growth

Our managed accounts journey is approaching five years and like the broader SMA industry, we believe the sky is the limit as more advisers and their clients gravitate towards them.

A report last year showed that ’managed accounts’ FUM exceeded the $200 billion mark to reach $205.6 billion – representing a six-monthly rise of $10.6 billion. This was underpinned by new investment inflows of $14.9 billion.”²

There’s no reason for the industry to cap its SMA ambitions.

For our part, we’ve built, by design, an institutional-grade managed accounts program leveraging our size into scale, backed by our manager-selection expertise, supported by infrastructure across trading, performance and attribution analysis, compliance, and governance.

It builds on what is a 40-year journey of multi-asset, multi-manager investment management, delivering strong outcomes for our clients.

Advisers and their clients are kept in the loop with relevant, and timely communication that we believe provides insights into our thinking, decision-making, processes, positioning and results.

We look forward with enthusiasm to see what the next five years will bring to SMAs with MLC Managed Account Strategies.