Separately Managed Accounts (SMAs) Made Simple

Separately managed accounts (SMAs) are widely used by fund managers, not only as a way to start their business but also to accommodate larger investors that want favorable terms, transparency, and the ability to “take over” the account if needed. In this article we’ll explain the appeal of SMAs, as well as challenges and the possible alternative options that may arise in the management of these accounts.

SMAs Explained

To start one of these accounts an investor simply opens a brokerage account in their own name and gives the fund manager authorization to make trades within the account (the manager cannot move funds or investments out of the account). Investors love SMAs for their transparency and control. Having constant access to the account and seeing every trade and position is as much as you can ask for. Having the ability to pull control from the manager at any time if you see they are performing poorly, having “style drift,” or experiencing the proverbial “hit by the bus” scenario gives investors comfort.

Managers and Challenges

Many new managers have already been trading their own, family and certain friends’ accounts, which has brought them to the point where they want to have their own fund. They have been making great returns, but also know that having to place trades in several brokerage accounts for a single trade idea is time-consuming and, depending on how fast the market is moving, not all accounts will get in or out of a position at the same time, meaning results can vary greatly.

One challenge that I have seen managers face when handling several SMAs is the cost of leverage for the accounts. Prime brokers have a scaling interest rate depending on the amount of capital in the account. The higher the amount, the lower the rate. The leverage rate is done on an account by account basis. You may have a lot of capital across many accounts but that doesn’t help your rate on an individual account.

Are They Worth It?

Due to the recent scandals, many larger investors are only placing money with fund managers through SMAs. Managers always want to grow their fund, their “baby.” Some feel insulted that investors want SMAs and take the approach that “this is my fund to invest in, take it or leave it.” I can understand that to some extent, but I also tell fund managers that this is a business and the more assets you can generate fees from and use—take care of yourself, your family and your staff, it’s best to put the “insulted” feelings aside and take the opportunity (if you can).

Fund of One

An alternative to an SMA for a large investor is a fund of one. It is not as easy as opening a brokerage account in the investors name and starting to trade, but it does have some great advantages for both the fund manager and the investors. As the name suggests, the manager and the investor create a simple fund structure with only one investor and the manager acts as the general partner of the “fund.” It can operate in the same manner as the SMA as far as transparency and control are concerned. The investor can open the fund to others at any point if they want and reduce the costs of running the structure. The manager benefits, as both management and performance fees are paid by the investor and are ordinary income to the manager.