According to data from State Street, separately managed accounts (SMAs) are now used by the majority of financial advisers (56%). The use of SMAs represents a significant change from the historical service provided by advisers, which was formulating and managing a portfolio for their clients.
An SMA allows an adviser to outsource this function to a qualified third party like an investment manager. They generally will offer off-the-shelf solutions to fit the vast majority of client situations and risk profiles. Solutions that are considerably more flexible than the portfolios they are replacing.
No doubt that moving the portfolio management of clients into arguably more qualified hands is a good move for the industry, but is it the best option for the general population? What does this say about the remuneration model that remains ubiquitous in spite of these changes?
What is an SMA and what is it replacing?
A Separately Managed Account (SMA) is a portfolio of assets managed by a professional fund manager, distinct from a traditional managed fund in one key way: investors retain direct beneficial ownership of the holdings. In a managed fund, assets are owned by a custodial company on behalf of the investor. Similarly, investing through an ETF provides ownership of fund units rather than the underlying shares.
This indirect ownership structure has a significant drawback: investors cannot directly transfer management of their assets or take control themselves. Discontent with a managed fund’s performance often means selling units, triggering potential capital gains tax and the costs of reinvesting elsewhere—frequently in similar assets.
SMAs, however, offer flexibility. For example, an investor with an SMA focused on ASX shares can switch to another SMA with a similar investment strategy without liquidating the entire portfolio. Only the shares needing reallocation for the new manager’s strategy would be traded, minimising transaction costs and reducing tax impacts compared to a managed fund.
Additionally, SMA investors can remove their portfolio from management entirely, holding the assets independently, as they would with a standard direct-share portfolio.
However, this structure can add complexity. An SMA might include over 50 individual shares, and every transaction made by the manager will appear in the investor’s account. This level of detail, while transparent, can make the portfolio appear more complicated than simpler pooled investments.
Advisers and SMAs
Most SMAs are accessible through wrap platforms, which typically require a financial adviser. You can learn more about wraps here.
While the benefits of direct ownership are substantial, they are not the primary reason advisers are increasingly recommending SMAs. The shift is largely driven by advisers outsourcing portfolio management to third-party investment professionals.
This trend is particularly evident with multi-asset SMAs, which invest across various asset classes, such as shares, property, cash, and fixed interest. Providers offer portfolios tailored to different risk profiles, combining growth and defensive assets. These portfolios often include not only direct shares but also managed funds and ETFs, reducing the utility of direct ownership in some cases.
Historically, many advisers would build a portfolio of managed funds for each client. SMAs are being sold to advisers as they both reduce the time to manage these portfolios, and the perceived liability of making these decisions in-house. Instead of spending the time vetting managers and watching the performance in order to build a portfolio, an adviser just needs to make one decision – which SMA provider to choose?
Once the choice is made, the provider will likely offer a multi-asset portfolio to suit whatever client they come across.
Some advisers diversify further by incorporating multiple SMAs within a single client portfolio, with the idea of spreading the risk of underperformance across different managers.
Is the move to these portfolios benefiting end clients though, or is it simply a way to create efficiencies within an advice practice?
Benefits of SMAs vs Typical Portfolio Management
Most financial advisers and firms lack the professional expertise required to thoroughly evaluate and manage investment portfolios. Even within the funds management industry, professionals rarely claim expertise across both fixed interest and equity markets. How, then, could an adviser be expected to interpret often conflicting information from various fund managers and assemble it into a cohesive portfolio?
This challenge is compounded by the adviser’s primary responsibilities, which often hold greater importance for clients: strategic advice, tax optimisation, navigating superannuation limits, and managing insurance needs. Expecting advisers to maintain a high level of portfolio management expertise alongside these responsibilities is simply unrealistic.
An SMA addresses this gap by ensuring the client’s portfolio is managed by a dedicated professional team, whose sole focus is investment management. This provides clients with confidence that their portfolios are being handled by specialists, freeing advisers to focus on their core strategic functions.
Additionally, many SMAs offer customisation options, allowing investors to exclude specific securities or sectors from their portfolios. This feature can be particularly valuable for those with large existing holdings in a particular stock or for individuals who wish to avoid certain industries due to ethical or personal preferences.
In this way, SMAs not only deliver professional portfolio management but also offer flexibility and personalisation, making them a practical solution for both advisers and their clients.
Problems with SMAs
To invest in an SMA, clients’ funds must be placed within a wrap platform, which introduces additional fees on top of the SMA’s investment management fee. Ironically, the SMA structure may undermine one of the key benefits of these platforms: transparency.
A major advantage of wrap platforms is their dedicated cash account, through which all transactions are processed with clear visibility. However, in an SMA, where each security is owned directly, every transaction made by the manager or dividend received is recorded on the wrap account’s transaction statement. While this isn’t inherently a disadvantage, it can result in extremely lengthy statements—sometimes exceeding 100 pages.
This complexity can create challenges for accountants, particularly if the investment manager trades frequently, as reconciling tax implications becomes more difficult. Some wrap account tax statements are known to occasionally mismatch with ATO pre-fill data, further complicating tax reporting.
There is nothing particularly wrong with the structure of an SMA itself though. Direct ownership and the removal of adviser management are arguably large benefits.
With that said, an SMA is still likely to be actively managed and thus cost more than their index counterparts. So, whilst the direct management of the portfolio is outsourced, an idiosyncratic risk remains. The risk that the particular SMA manager chosen by the adviser underperforms an equivalent benchmark.
History tells us that most will do just that. Most importantly though, how does the adviser respond to such underperformance? The conflict identified in this article remains with SMAs and may even be increased, especially if only a single multi-asset portfolio is chosen for most clients – thereby increasing scrutiny.
Asset-Based Advice Fees Remain
Financial advice firms that use SMAs and continue to charge asset-based fees are opening themselves up to considerable scrutiny.
After all, if you no longer manage the portfolio, why is your fee based solely on the value of that portfolio?
The justifications for such fees are slim even if a portfolio is being managed by the adviser – a $1m portfolio does not take double the effort to manage than one with $500k.
Instead, advisers will make the justification that the financial risk of malpractice scales with the funds being managed – especially when it comes to implementation. Trading mistakes and things of that nature. On the surface, this is a fairly weak explanation of the prevailing remuneration structure of the industry – especially when professional indemnity insurance is considered. However, it is one that is ubiquitous for those using this structure.
With the introduction of SMAs, this justification erodes further. When portfolio management is outsourced to an SMA provider, the adviser’s role in research, implementation, and trading diminishes significantly. This outsourcing reduces not only the adviser’s workload but also their direct accountability, leaving little basis for fees tied to portfolio size.
Even if the intentions were originally pure, asset-based advisers using SMAs have opened the Pandora’s box of not actually managing portfolios anymore. The scariest thing for an adviser is not a market crash, but a client asking them to justify their fees – especially if said fees are based on assets.
Summary
SMAs represent an interesting evolution in portfolio management, offering a structure whose benefits largely outweigh its downsides.
The direct ownership and professional management they provide are appealing, but most SMAs remain actively managed, exposing them to the familiar risks of active management underperformance. Advisers still face the challenge of selecting the right SMA provider and deciding how to respond to poor performance.
In short, there is nothing wrong with an SMA as an investment structure. However, as most are actively managed, SMAs will naturally be discounted by the passive investment community who will continue to prefer index ETFs.
There is a best of both worlds option though. Direct indexing, which is gaining popularity in other countries is not readily available yet in Australia. Direct indexing involves an SMA replicating an index, such as the ASX 200, by holding its individual shares. This approach combines the advantages of direct ownership with passive investment principles, avoiding active-management risks while allowing customisations like excluding specific stocks or sectors for ethical or personal reasons.
For now though, the distribution of SMAs seems to be mostly through advisers who are using them to outsource their own portfolio management function. On balance, this is likely to be a benefit for clients – but it opens a significant question about the engrained remuneration structure of the industry. One that might be the cause for some awkward conversations with clients in future.
After all, if you no longer manage the portfolio, why is your fee based solely on the value of that portfolio?
