The choice between separately managed accounts (SMAs) and pooled funds is a hot subject of debate among financial enthusiasts. As both options offer unique benefits and potential drawbacks, it’s important to consider your personal financial goals when deciding between them. So should you choose an SMA, a pooled fund, or perhaps both? Read on to find out. 

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What are Separately Managed Accounts and Pooled Funds?

Separately managed accounts, sometimes referred to as separate accounts, are individual investment portfolios managed by professional asset managers. Unlike pooled funds, SMAs provide direct ownership of securities, offering a personalized investment strategy. Investors have the luxury of tailoring their portfolios to suit their financial objectives, risk tolerance, and personal preferences.

Key Characteristics of SMAs:

  • Customization: Investors can tailor their investment strategy to their specific needs.
  • Transparency: Direct ownership of securities allows for greater visibility and control.
  • Tax Efficiency: Investors can manage their tax liabilities more effectively.
  • Professional Management: Managed by seasoned professionals to optimize returns.

Pooled funds, such as mutual funds and exchange-traded funds (ETFs), aggregate capital from multiple investors to invest in a diversified portfolio of assets. This collective investment approach is managed by professional fund managers, providing investors with access to a broad range of securities that might be otherwise unaffordable.

Key Characteristics of Pooled Funds:

  • Diversification: Spreading investments across various assets reduces risk.
  • Accessibility: Lower minimum investment thresholds make it easier for individual investors to participate.
  • Liquidity: Generally easier to buy and sell shares compared to individual securities.
  • Professional Management: Fund managers make investment decisions on behalf of investors.

So, in a nutshell, pooled funds combine money from multiple investors into a single portfolio, offering shared returns. Separately managed accounts, by contrast, are individualized portfolios tailored to the holder’s unique needs and preferences. 

Comparing Costs and Fees

Pooled funds tend to be less expensive due to shared management and administrative costs among all investors. As you might expect, separately managed accounts come with higher fees because they offer personalized, bespoke investment management services. Here’s an in-depth cost comparison between the two.

Pooled Funds Cost Breakdown

Pooled funds primarily charge an expense ratio, which is a percentage of the total assets in the fund and covers management fees, administrative costs, and other operating expenses. Expense ratios are calculated using this formula:

Annual fund expenses / total assets under management = expense ratio 

For example, if the fund costs $80,000 per year in operating costs and has $8 million in assets, its expense ratio would be 0.01 (1%). 

In addition to the expense ratio, some mutual funds may impose sales loads and redemption fees, though these are becoming increasingly uncommon in newer, low-cost options. You should also be prepared to pay transaction fees when buying or selling shares.

Separately Managed Accounts Cost Breakdown

The main cost you can expect with a separately managed account is the management fee, usually calculated as a percentage of the assets under management (AUM). This fee ranges from 0.5% to 2% on average annually. Generally speaking, the larger the account, the lower the fee percentage.

SMA clients may also incur trading costs, as each account is managed individually and may involve frequent buying and selling of securities. Custodial fees, which cover the cost of holding and safeguarding the assets, may apply as well.

Performance and Risk Management 

Performance and risk management are pivotal factors when considering SMAs and pooled funds. SMAs allow investors to directly manage risk by selecting or avoiding specific securities. This personalized approach can result in higher returns if managed correctly, especially in alignment with individual risk tolerance and market conditions.

Pooled funds, on the other hand, offer built-in diversification, which mitigates risk by default. The downside to this is that investors have limited control over specific holdings within the fund. The expertise of the fund manager plays a critical role in the fund’s performance, and past performance is not always indicative of future results. 

Tax Considerations for Separately Managed Accounts and Pooled Funds

Don’t forget about taxes! Both SMAs and pooled funds can have major tax implications, and it’s important to understand how they align with your financial objectives. Separately managed accounts provide investors with greater control over realizing capital gains and losses, allowing for strategic tax planning. Investors can choose to defer gains or realize losses to offset other income, potentially resulting in lower tax liabilities.

Pooled funds distribute capital gains and dividends to investors, which can lead to unexpected tax obligations. For instance, if the fund holds dividend-paying stocks, those dividends are distributed to investors and are taxed as income. For mutual funds, ordinary dividends are taxed as ordinary income at a maximum rate of 37%. 

Choosing the Right Investments for Your Portfolio

There isn’t one right or wrong answer when it comes to choosing between SMAs and pooled funds––it all depends on your financial goals. Both have their pros and cons so if you’re looking to minimize risk while maximizing returns, you might even consider including each type in your portfolio. By considering the factors listed above, you can develop an investment strategy that works for you.

 

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PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. All investments involve risk, including the loss of principal.