Ever since they were introduced by E.F. Hutton in the 1980s, separately managed accounts (SMAs) have held out great promise: for tax harvesting and other efficiencies, for customizing portfolios, for access to boutique managers. Additionally, their high minimums—$100,000 and up per manager—give them an aura of exclusivity that mass-market mutual funds lack.

However, no one except the most die-hard SMA enthusiasts—and sometimes not even these—would argue that SMAs have consistently realized their potential. The number of accounts that actually make use of SMAs' advantages is so low that it raises questions about the efficacy of SMAs and the mind-sets of advisors (and clients) investing in them. Only 9% to 12% of the accounts show evidence of active tax management, according to the most recent analysis from Dover Financial Research/The Money Management Institute (the national organization for the managed accounts industry). True customization is equally rare.

What's more, access to otherwise unreachable managers is no longer a crippling problem, now that many of the big names in money management also run mutual funds. Finally, any air of exclusivity (and the requisite bragging rights) has been upstaged by the more exclusive, yet conversely higher-profile alternative investments like hedge funds and private equity.
Perhaps this accounts for the seeming stagnation of SMAs, with recent inflows largely flat. 

"SMAs could have so much promise," says Steve Deutsch, director of separate accounts at Morningstar. "But once they are sold, the advisor or consultant doesn't treat it as a consultative relationship, they treat it as a product. They sell it and forget it."

Unlocking the Promise 

The industry's hope for the future, as well as its method for unlocking SMAs' unrealized potential, lies in a new platform already making rapid inroads: the Unified Managed Account (UMA). This single account has the ability to integrate multiple vehicles, including SMAs, ETFs, mutual funds and some alternative investments. An overlay manager on top of the account can manipulate the UMA for tax or other efficiencies.

Closely related to the rise of UMAs is the growth of model portfolio programs. Essentially, the asset manager becomes a research provider and strategist, submitting intellectual capital to clients in the form of a model portfolio of securities he or she has selected. The overlay manager is responsible for all execution and trading. This separation of research and strategy by the manager and implementation by the overlay provider is set up to lead to increased efficiencies in the portfolio. 

"The upside is that unified managed accounts finally deliver on the promises of SMAs," argues Randy Bullard, executive vice president of Placemark Investments in Dallas, a leading UMA overlay manager. Take tax optimization, for example: Bullard says that UMA software can take this beyond simple tax harvesting to include "preemptive tax management," such as deferring sales to take advantage of long-term gains. This is a far cry from advisors trying to tax harvest at year-end and manually juggling numerous SMAs.

The increased ease of tax optimization in UMAs vs. SMAs is supported by real data. A study by Dover Financial/MMI found that 37% of UMA programs employ some sort of tax management, a statistically significant jump from the situation for SMAs.

Beyond the tax optimization capability and trading efficiencies, UMAs offer administrative simplicity. For one thing, advisors have consolidated oversight. Additionally, because they can handle many different vehicles and asset classes, advisors using them can more easily diversify portfolios. Michael Winnick, managing director of strategic partnerships at Russell Investments, says that, as a result, "UMAs could become a catalyst for increased portfolio diversification and for ultimately remedying the deficiencies of SMAs." 

These advantages have been reflected in the rapid growth of what is still a very young industry. Estimates tallied by Dover Financial/MMI project that the model portfolio subset of UMAs will capture $385 billion in assets, nearly half of the total SMA market, within five years. 

Similarly, Schwab Institutional, a UMA platform provider that also allows advisors access to different overlay managers, has seen momentum in the UMA market. Unlike most custodians, Schwab has also seen steady growth in SMAs, particularly for clients with more than $2 million under management. Jeff Carlin, vice president of managed accounts at Charles Schwab, says, "We think UMAs will become powerful in the RIA space, because they will simplify the back office, unlocking opportunities in the front." 

Not So Fast... 

This upbeat scenario of a future dominated by the technological marvels of UMAs and revitalized SMAs is not without its skeptics and outright critics. Cost is the first roadblock. There is a fee for overlay management, although often this is exactly offset by trading efficiencies resulting from model portfolios, leading to no net increases for the client. But tax optimization has an additional fee of five to 10 basis points or more, and overlay managers will need to demonstrate value here. 

More crucially, advisors may already have access to many of the features touted as being unique to UMAs. "Effectively, most advisors have the equivalent of a UMA on their mutual fund platform," says Bob Veres, publisher of the online newsletter Inside Information. The crucial difference, he says, is that these consolidated accounts don't include SMAs. Therefore, Veres thinks the emphasis on UMAs is just a way to get clients to invest in SMAs. "Have you noticed whenever you hear UMAs you also hear SMAs?" Veres asks. "UMAs are a way to bring SMAs back into the conversation, but in a sneaky way." 

Morningstar's Steve Deutsch also speaks guardedly. "UMAs have been put forward by the wirehouses as the next great hope for the SMA industry," he explain. "The industry moved on to UMAs from MSPs (multiple style portfolios). So far, I wouldn't agree that UMAs have lived up to their promise or potential as initially positioned by Wall Street. The assets have not poured in."

One User's Experience 

Despite these industry observers' skepticism, some RIAs are already using UMAs—and really loving them. Greg Gardner, president of the Gardner Group in Dallas, has been using SMAs for the past six years but recently transitioned to a UMA platform to "simplify things." The experience has been successful. "It reduced paperwork, and I think the tax optimization feature has paid for itself," says Gardner. The UMA also have allowed Gardner to improve diversification: He could expand clients' asset mix, in part because managers reduced their minimums to gain access to the UMA platform. 

The most noticeable change is in his workload at year-end: "We used to spend most of our December doing tax harvesting," he says. "This is now taken care of throughout the year." Charlotte, N.C.-based Atria, Gardner's overlay manager, also monitors potential wash sales and duplicate holdings.

Gardner's experience with UMAs, however, may not be representative. He had already been tax-optimizing his SMAs, which puts him in a minority. This points to a larger overall problem: SMAs exhibited great promise, albeit mostly unrealized. UMAs have even greater promise, but they face many of the same challenges.

Robert N. Gordon, chief executive officer of the Twenty First Securities Corp. of New York City and an expert on tax-efficient investing, spells it out in this way: "I think it comes down to people's behavior, how they really use things, rather than any potential benefits. It's a shame that SMAs in their present form are not being fully utilized. But unless you change investors' behavior, giving managed accounts a new acronym isn't going to change anything." 

David E. Adler, a New York-based freelance writer, is a frequent contributer to Financial Planning.