Future Focus: Advisers are investing in droves in this product
What’s so special about SMAs?
The investment industry is always innovating. The goal is to introduce products with features that will attract as much investor cash as possible. The features of these products are intended to appeal to individual investors and financial advisers.
One product that is increasingly popular with Australian financial advisers is Separately Managed Accounts (SMAs). If you use a financial adviser, you may find yourself investing through a SMA. Investment Trends research shows that 3 in 5 Australian advisers use managed accounts, with 71% of their clients’ total assets in these accounts. The market for SMAs for self-advised investors remains nascent.
What’s the appeal of these platforms?
We can look to how they’re structured to understand why they are appealing.
Separately Managed Accounts allow investors to beneficially hold every security in their portfolio. This is compared to vehicles such as ETFs or managed funds where you hold ‘units’ in a vehicle that owns the assets, but you do not have ownership over the individual securities.
For example, if you want exposure to the ASX 200 you can buy an ETF like the SPDR S&P/ASX 200 ETF (ASX STW) which owns the underlying shares in the index. Or you can buy an SMA which directly provides you with beneficial ownership of the 200 shares individually.
The difference between owning an investment structure that owns the underlying shares and directly owning them provides flexibility to do the following:
Exclude certain stocks or securities
You may decide that you already have enough exposure to mining, and that you will reduce exposure there. You may decide for ethical or other reasons you don’t want to own mining. An SMA provides the flexibility to do that.
Avoid the tax consequences from the actions of other investors
Investor actions can force the hand of a fund manager. If too much money is pulled from a managed fund the manager will have to sell to meet the outflows which may generate capital gains. With an SMA you have a greater degree of control over your tax consequences. This feature increased the popularity of SMAs in the US after the Global Financial Crisis (GFC) after many investors got burned by the poor behaviour of other investors.
Get the tax benefits of beneficial ownership
When you own an ETF or share, you own units in the vehicle. The basket of shares the ETF or fund represents must either all be sold or all retained. The tax consequences of your action is based on the vehicle and not the underlying shares. Having beneficial ownership means that you are able to make decisions that may reduce your tax obligations.
For example, take the below portfolio of 3 shares:
This portfolio has achieved a 2.6% aggregate return. However, the underlying assets have different returns. If this portfolio was an investment product like a managed fund or an ETF, you would incur tax on that gain if you sold all or part of the investment.
For SMAs, you are able to decide which assets you buy and sell. This means that you have the choice to sell Share C, incur the capital loss and offset it against other realised gains. Across portfolios with large balances, this can make a meaningful difference and the options for your tax strategy broaden.
Transparency
SMAs allow you to see what you’re holding, and the exact quantity in which you hold it. This is especially attractive for investors in Australia where it is not mandated to show full holdings for managed funds. Usually, fund managers share their top 10 holdings and the proportion in which they hold them. I believe this practice is insufficient for investors to holistically plan their portfolios with the confidence that they have the correct exposure to asset classes and securities. They should know what they are invested in. SMAs allow for this.
Reporting
SMA platforms often also provide detailed attribution and tax analysis. This helps investors doing portfolio reviews and provides greater insights into the underlying investments. Recently, I wrote an article on how financial advisers improve returns by 3%. The research shows that one of the major reasons for this outperformance is the tools and software that give investors an analytical edge.
Why do advisers love SMAs?
Many of the reasons I outlined above make SMAs popular with advisers and investment consultants. For clients with larger balances, a similar solution called Individual Managed Accounts (IMAs) are also utilised. They provide the ability to have a personalised investment strategy with complete control of the individual securities in a relatively cost-effective manner.
Importantly for advisers, these platforms also allow them to make changes that will apply across a variety of clients. If they decide to remove an equity from the portfolio, they can do this across their whole client book. This makes their life a lot easier.
In the Investment Trends research I previously referenced, advisers provided the three top reasons for increased use in SMAs:
- The ability to achieve full asset allocation through managed accounts (this is the ability to access multi-asset models);
- Availability of managed accounts on more platforms; and
- Ease of setting up/managing my own managed accounts.
A more cynical perspective is that advisers like SMAs and IMAs because they make clients stickier. Getting your client into a product where you have to actively manage and adjust the individual securities means that they’re likely to stay with you. If a client is in an adviser’s own portfolio, discontinuing the service means that the portfolio usually remains stagnant with no further changes being made to the unmonitored portfolio. On the SMA side, the fact that many investors are unfamiliar with SMAs provides additional incentive to stick with an adviser.
What type of investors do they suit?
Like any other investment product, SMAs will suit a particular type of investor. Who they suit is linked to many of the factors listed above.
SMAs tend to suit investors with higher balances. This is because you do not own units in an investment trust – you directly own the security. The tax efficiency benefits and customisation become noticeable at scale.
The tax efficiency benefits disproportionately help investors on higher tax brackets. It’s worth more to your net portfolio outcome.
SMAs also suit investors that place a greater value on transparency and control. You get to decide what you own and the exposure you have to the asset. This may particularly suit investors that want to exclude investments from their portfolio for strategic or impact reasons.
There are plenty of options in the managed fund and ETF space for investors that may be looking for an ESG solution. With off the shelf ESG products there is a lack of transparency and various definitions of what constitutes ‘ESG’. This can prevent an investor from expressing a unique set of values on a portfolio.
How much do they cost?
Cost is always a critical component of investing. I’ve written before on how fees are one of the largest determinants of your total return outcomes. Keeping them as low as possible will maximise your returns.
However, fees can be justified if the benefits outweigh the costs, particularly tax efficiency and control of holdings.
We can use Praemium, an SMA platform, as an example. Below are the costs for Praemium’s SMA platform.
Source: Praemium SMA Product Disclosure Statement (PDS). Certain disclaimers have been omitted in this summary. For more information, see Praemium.
There are a variety of costs associated with owning and maintaining an SMA. They are particularly expensive on a relative basis for lower account balances given the flat fees and tiered costs.
What are the alternatives?
The market for accessing SMAs as an individual investor is nascent in Australia. SMAs are usually only available through a financial adviser in this country.
What are the alternatives for individual investors that are looking for a similar solution?
No investment product is a perfect solution. Find the strategy that ticks most of your boxes.
One alternative is to stick with the managed funds and ETFs on offer. You are not paying multiple ongoing fees to own investments. This is different from an SMA when there are fees to hold them on a platform in addition to the fees from the adviser.
If tax is your main concern, ETFs are particularly tax efficient comparative to managed funds. They do not force investors to inherit the capital gains consequences of other investors that have decided to leave the fund.
ETFs are also transparent. You are able to see the holdings of ETFs and understand what you are invested in.
Lastly, if you want to control your outcomes and care about what you hold, individual shares are the answer. You have complete control over the investments and can manage when you buy and sell them without any external influence on tax, transaction costs, or rebalancing frequency. What you lose here is the administration and portfolio reporting, and the ability to make decisions across multiple portfolios. As an individual investor, you’re not really losing much here.
I’ve written before on my investment strategy and what works for me. SMAs aren’t for me. I can’t justify the cost and I don’t have a large enough capital base that justifies the tax advantages. Investors who engage a financial adviser are much more likely to have a large balance that would make the fees for an SMA much more palatable.
A large part of finding success as an investor is understanding what works for you. There is never a perfect fit in the investing world. All we can do is have enough honest introspection to understand our financial goals and what is achievable given our circumstances. Then, work on understanding the best solution for us.
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