What Is a Separately Managed Account? You Own the Securities, Not a Slice of a Pool

A separately managed account, or SMA, holds individual securities in your name. A manager runs it to a stated strategy, and you own the stocks or the bonds directly. Not a share of a pooled fund.

That one difference drives everything else. Tax treatment, customization, transparency, minimum size, and the amount of administrative work behind the scenes all follow from direct ownership.

I run an ETF business and I have run separately managed accounts for advisers for years. What follows is how one actually works, including the parts that rarely make the brochure.

How does a separately managed account work?

You open an account at a custodian. Schwab, Fidelity and Pershing are the common ones. The account is yours. Then you hire a manager and give them trading authority on it.

The manager runs a model. When the model says buy Microsoft, the manager trades it in your account, and in every other account on that model.

Trades are usually placed as one block and allocated across accounts, which keeps execution fair. Your holdings still drift a little from the model, because you funded on a different day at a different price.

Your statement lists the actual shares. Not a fund name.

What is the difference between a separately managed account and a mutual fund?

A mutual fund pools everyone’s money. You buy a share of the pool. The pool carries one cost basis history and one set of realized gains, and you inherit both on the day you buy in.

An SMA gives you your own copy of the strategy. Your cost basis is yours. Nobody else’s redemption creates a taxable event in your account.

• What you own. A pooled fund gives you a share of the pool. An SMA gives you the securities themselves.
• Tax lots. A fund hands you a shared history you inherited. An SMA starts your lots the day you funded.
• Customization. A fund offers none. An SMA can exclude a stock, a sector or an industry.
• Transparency. A fund reports holdings on a lag. An SMA shows them daily on your own statement.
• Minimum. A fund costs one share. An SMA commonly runs $100,000 to $250,000.

An ETF sits between the two on tax, for a structural reason worth reading separately. See why ETFs are tax efficient and how ETFs compare with mutual funds.

Why does direct ownership matter at tax time?

Because losses inside an index are invisible when you own the index as one line.

An index can be down for the year while a third of its members are up. Own the fund and you see one number. Own the names and you can sell the losers, book the loss, then buy something similar and stay invested.

That is tax-loss harvesting, and it is the main reason advisers move taxable money into an SMA.

A worked example: inside the S&P 500 in 2022

The S&P 500 fell about 18% on a total-return basis in 2022. One line on a statement. One loss.

Underneath, the spread was enormous. Meta finished the year down about 64%. Tesla fell about 65%. Amazon fell about 50%. In the same index over the same twelve months, Exxon Mobil rose about 80% and Chevron rose about 53%.

Own the index fund and you have one lot showing a loss. Hold the 500 names and you have dozens of lots deep in the red, beside winners you never had to touch.

You harvest the losers in March, again in June, and again in October. The strategy stays intact and the losses go on Schedule D.

2022 was unusual in the size of the drop. It was not unusual in its dispersion. Even in a strong year, roughly a third of index members finish lower.

When does the tax benefit run out?

Harvesting needs lots trading below what you paid. Those are thickest early, while the account still sits near its funding price. Most of the benefit lands in years one through five.

A ten-year-old account in a market that went up is mostly embedded gain, with very little left to sell at a loss. The fee keeps running either way. Redo that calculation every few years, not once at the open.

How do you start a separately managed account?

Five steps, in order.

1. Open an account at a qualified custodian, or use the one the client already has.
2. Sign an investment management agreement that grants the manager discretion.
3. Fund it with cash, or transfer securities in and keep their existing basis.
4. Put your restrictions in writing, like a sector to exclude or a legacy position to leave alone.
5. The manager then trades the model in your account.

Advisers usually reach a manager through a platform rather than directly. Those platforms are called managed-account programs, or TAMPs. Envestnet, Orion and the custodians’ own programs are the common routes. The program handles the paperwork, the billing and the trade sequencing. It takes a slice of the fee for doing so.

Why doesn’t everyone run one? Start with the minimum

Two portfolio managers who ran SMAs for decades before launching ETFs put the same number on it, independently, on Behind the Ticker.

Kirk McDonald is a portfolio manager at Argent Capital Management, which ran separately managed accounts for 24 years before it launched a fund. His description of the entry ticket: "when you’re doing separately managed accounts, you need, you know, a hundred thousand dollars to $250,000 at a time". The fund, he said, was how the firm gave people access "for a few dollars at a time".

Jeff Cullen, Managing Director at Schafer Cullen Capital Management, quotes the same figure on a strategy his firm has run in SMA form for 14 years. Because it writes options on the underlying names, "it’s a $250,000 minimum per account". Advisers came to him asking for the strategy in IRAs and in smaller accounts, "because it’s easier to implement and I can get it at a lower minimum".

The minimum is not a gate the manager invented. Below it, an account cannot hold enough positions to track the model, and the tracking error swamps the tax benefit you came for.

What does it cost to operate? Every account is its own account

A fund is one portfolio with one set of books. A hundred SMAs are a hundred portfolios with a hundred sets of books.

Raymond Holst is a tax attorney at Practus LLP who works on the 351 exchanges that move these portfolios into fund structures. Testing one, he cannot look at the strategy in aggregate: "if you’re running separately managed accounts, maybe you have 50 accounts. You have to look at each account individually. It’s not the aggregate portfolio." Each account’s own cost basis and holding periods then have to travel "from the current custodian into the new fund administrator".

Cullen’s firm manages 13 separate SMA strategies and picked one to run as a fund as well. He describes that version as "very, very easy to implement across the board versus the paperwork and everything that goes involved with a separately managed account".

What happens when the strategy trades a lot?

Direct ownership means your losses are yours. It also means your gains are yours, in your tax year, whenever the manager trades.

Sal Esposito of Zacks Investment Management ran into that directly. Zacks looked at putting its small and mid-cap portfolios into a fund because of what turnover does inside an account: "they have 100% turnover in them. A lot of advisor pushback on 100% turnover in a separately managed account."

Bob Elliott, co-founder and CIO of Unlimited, makes the same point about a strategy that shifts positions often. Inside a fund the investor sees a single holding, "without the investor having to, you know, absorb short term capital gains that could come from, say, a separately managed account".

The pattern across all four practitioners is the same. An SMA suits a strategy that trades lightly and holds appreciated positions. A strategy that turns over hard is a poor fit for a taxable account you own directly.

What are separately managed account fees?

You pay the manager a fee on assets, billed from the account each quarter. If you came through a platform, its fee sits on top. You also pay the custodian, though trading is commission-free at the major ones now.

Compare that against a fund’s all-in cost, not against zero. A fund charges its fee inside the net asset value where you never see it. An SMA charges it on a statement line where you do. Same money, different visibility.

How are separately managed accounts regulated?

The manager is a registered investment adviser. It files Form ADV, and Part 2A describes the strategy, the fees and the conflicts in plain language. Read it before you sign anything.

Your assets stay with a qualified custodian, not with the manager. That split is the point. The manager can trade your account and cannot move money out of it.

A managed discretionary account is the broader term. Any account where someone trades without asking you first is discretionary. An SMA is a discretionary account run to a stated model.

What is the difference between a UMA and a separately managed account?

A unified managed account holds several models in one account. An overlay manager sequences the trades so two models do not fight each other. If one model sells Microsoft while another buys it, the overlay nets the two.

You get one statement, one fee schedule and one tax-lot ledger. An SMA is one model in one account. A UMA is several, coordinated. The UMA usually costs more and gives up some customization inside each model.

How does direct indexing use a separately managed account?

Direct indexing is an SMA that holds an index’s members instead of a fund that tracks it. The point is the losses. You cannot harvest inside a fund and you can inside the names.

Most direct-indexing accounts track a broad index and harvest on a set schedule. The strategy is just the index. The product is the tax management wrapped around it.

Are there municipal bond, private equity and crypto separately managed accounts?

Yes, and the municipal bond version is the oldest of the three. A muni SMA buys individual bonds. You can match maturities to a client’s cash needs, and hold only your own state’s paper. A bond fund cannot do either. Bond ETFs solve a different problem.

Private equity and crypto versions exist too. Both are newer. Both carry custody and valuation questions a stock SMA does not, and both deserve diligence of their own.

When is a separately managed account the wrong answer?

Often. Here is when it fails.

In a retirement account. The tax machinery is the main reason to pay for an SMA. In an IRA there is nothing to harvest, so you are paying for an idle machine. Esposito, who sold SMAs at UBS before he moved to ETFs, now says he does not see why anybody would use one "unless they were using an index-based tax-managed fund". Read that as a statement about which job the wrapper is for.

When the account is small. Below roughly $100,000 you cannot hold enough names to track the strategy.

When the strategy trades a lot. Harvesting needs losses. A high-turnover strategy in a rising market realizes gains instead, and the bill arrives every year.

After the first several years. The harvest front-loads, and a long-held account in an up market has little left to sell at a loss.

When the wash-sale rule bites. Buy a substantially identical security within 30 days either side of the loss sale and the loss is disallowed. That includes purchases in your IRA and your spouse’s account. Harvesting badly is worse than not harvesting at all.

When nobody owns the operations. Fifty accounts means fifty reconciliations, fifty billing runs and fifty sets of restrictions to honor. That work does not disappear because the model is good.

Where a risk-managed strategy fits

The same strategy can be delivered either way. THOR runs separately managed accounts for advisers and runs the same systematic signal logic inside its funds.

The approach is rules-based and seeks to reduce drawdowns rather than forecast them. The choice of wrapper is a question about the account, not about the strategy. Taxable money with a long horizon and low-basis stock is an SMA question. A retirement account is a fund question. Most advisers run both, because most clients bring both kinds of money.

Related reading: systematic investing versus discretionary and rules-based risk management platforms for RIAs.

Definitions

Separately managed account (SMA). A portfolio of individual securities owned directly by one investor and managed to a stated strategy.

Tax-loss harvesting. Selling a position below cost to realize a loss, then buying a similar security to stay invested.

Wash sale. A disallowed loss, triggered by buying a substantially identical security within 30 days before or after the sale.

Tracking error. How far the account’s result drifts from the model it copies.

Overlay manager. The party that sequences trades across several models in one account so they do not conflict.

Managed-account program. A platform that packages manager access, paperwork, billing and trade sequencing for advisers.

Educational content only. This is not investment advice and not a recommendation regarding any security. Securities and index figures are cited as historical illustration. Tax treatment depends on individual circumstances. Consult a tax professional. Investing involves risk, including possible loss of principal. Past performance is not indicative of future results.