Do you have a separately managed account? If so, you might want to reconsider.
What is a separately managed account?
This is basically your own private mutual fund. A money manager buys a number of securities that are held in your account. Your money manager makes the decisions as to what securities are held in your account, but you can provide guidelines and input. You get to see the actual stocks and bonds that are purchased. You have your own cost basis and you can tell the manager how to customize the portfolio to suit your needs.
Why brokerage houses love to sell separately managed accounts
Top financial planners won’t sell these, but salespeople will because they love fees and commissions. The broker charges an annual fee that can be as high as 3% annually. Also, separately managed accounts often hold over 100 securities. And there is often a great deal of buying and selling going on. When a broker does lots of trading, it costs you money. They may or may not charge you directly, but you pay for it.
One secret way you pay for these transaction is the “mark-up.” This is the difference between the price you pay the broker for the securities and the price the broker paid at first. The brokerage buys those stocks “wholesale” and then resells them to you at “retail” – with a mark-up. It’s very hard to know what that mark-up is. But just know that the more securities in the portfolio and the more often they are traded, the more a separately managed account costs you.
Why do investors buy these?
Some do it for snob appeal. The broker convinces them that they’ll have a customized portfolio. They go on to sell investors on the idea that the manager will watch each portfolio individually. The latter is false and the former isn’t a benefit.
The last thing you want is a customized portfolio. First, if you are skilled at picking securities, why hire a financial manager in the first place? But if you do hire someone to manage your money, the last thing you want to do is override his or her decisions.
Second, a customized portfolio is very hard to track. Your money manager has hundreds of clients. Maybe thousands. Do you think the advisor has time to watch every single portfolio every day? They don’t. And if your portfolio is different than everyone else’s, the advisor won’t watch it at all. In fact, the more unique your portfolio is, the more likely it is that your manager will ignore it completely.
Can I think of any reason to buy a separately managed account? No.
Some people will tell you that such accounts offer more control over income tax liability, but you can manage your taxes better by purchasing funds with low turnover. (Read ETFs vs. Mutual Funds.)
In short, the separately managed account is an invention of Wall Street to benefit Wall Street. Tell anyone who tries to pawn one of these accounts on you that you’re too smart to fall for it.
Neal@Wealth Pilgrim says
March 6, 2011 at 7:54 PM@Roger I agree with you. If the account is very large and they have restrictions that are faith-based or social-based, this can work. And I agree that this is vastly different from what brokers sell and overcharge for. Thanks.
@Don. I am a practicing financial advisor. I see clients come in with inappropriate investments like these all the time. As Roger said, there are a few cases where these can work but largely they are inappropriate – at least for the clients I’ve seen who have been sold this junk.
If you can get a SMA for 40 bps and no participation, you are likely referring to the types of accounts Roger referenced. If that is the case, I agree with you.
Roger Wohlner says
March 4, 2011 at 2:37 PMNeal as an advisor to several foundations and endowments I would partially disagree with you. One area where separate accounts can serve well is if the sponsoring organization has faith-based or other social restrictions that they want to avoid via their investments. Here a separate account may be the only way to adhere to these restrictions. However, from experience, these work best if the portfolio is large enough to meet the minimums of some of the better separate account managers. This is vastly different from what the brokers pass off as separate accounts via their overpriced wrap programs. I agree with you here that investors may not be well-served or be getting anything other than overpriced mediocre performance.
Neal says
March 4, 2011 at 11:49 AMI don’t usually and here’s why. The foundation has a responsibility to grow that money to achieve financial goals with as little risk as possible. They should not place unrealistic restrictions on the manager and then expect performance.
If the main objective is not to grow the money but to advance non-financial ideas, then they may have to go this route.
Don says
March 4, 2011 at 8:35 PMWhy if you can get the same manager for 40bps less then the expense ratio of the mutual fund is it a bad idea? We are comparing an existing mutual fund and the corresponding sma.
neal says
March 5, 2011 at 9:22 PMBecause you can’t get the services at that price.
Don says
March 6, 2011 at 7:47 PMYou can and do you think that you are qualified to give this advice since you haven’t been registered with finra for 8 years?
Pat says
December 14, 2010 at 4:45 PMYour article captured my attention until you inserted the pronoun “she” several times. Interesting choice since only 11% of all financial advisors are women. In the future you words would have more strength if you maintained the gender neutral “financial advisor” throughout. Regarding the actual recommendation, there are many SMAs out there with low turnover that only own 20 to 25 stocks, which is the point at which diversification within any equity class begins to diminish. With these funds you not only have lower fees (by the way show me any mutual fund and even some ETFs and I’ll show you 2% to 3% in fees), but you have the transparency that goes with knowing what you own. One of the biggest problems I saw in 2001 – 2003 and 2008 – 2009 is most portfolios have a significant amount of overlap without really realizing it. Just because you own 6 different semi-conductors doesn’t mean you’re not overweight in that sector. It is much easier to optimize a portfolio which clearly shows what you have. And don’t forget you can gift and transfer individual stocks out of an SMA which you can’t do with either a mutual fund or ETF. Bottom line is there are often appropriate situations for most of the types of investments that are out there, but both advisors AND investors need to be careful about getting carried away with any one of them.
Neal@Wealth Pilgrim says
December 14, 2010 at 10:25 PMI often refer to women in my posts because I am trying to make up for all the other posts out there that seem to relegate women to a 2nd class when it comes to money. My experience is that women tend to make most of the financial decisions and often better ones, and therefore, need to be shown more respect.
The Separately managed account argument really boils down to returns. Just as some funds are great, it would be a mistake to generalize and say all funds are great. So would it be a mistake to draw conclusions about SMA’s as a whole based on a few good ones. As a rule, they are not appropriate for most investors.
Don says
March 4, 2011 at 11:18 AMDo you think they are appropriate for foundations or endowments?
Corina says
December 5, 2010 at 8:00 AMthanks so much for sharing. These are some real great pointers.
Roger Wohlner says
December 3, 2010 at 7:47 PMGood post. If someone has less than several million dollars separately managed accounts are both a ripoff and not necessary. These and their first cousins the brokerage house wrap accounts are overpriced and frankly many top-notch actively managed mutual funds do a better job. With the advent of ETFs investors can construct their own well-balanced low cost portfolio.