Layers of fees can hurt investor returns on SMAs

With up to three layers of fees before you get your returns – Separately Managed Accounts may be popular and have many neat features, but they are far from perfect.

Separately Managed Accounts are often a great tool, but layers of fees can hurt returns.

Separately Managed Accounts (SMAs) are a way for investors to get access to professionally managed portfolios that have some neat features. However, investors need to be careful that there can be multiple layers of fees that can adversely impact the net performance of the portfolio.

Understanding how an SMA works is relatively simple. Rather than self investing in a portfolio of shares, ETFs and managed funds, a SMA allows you to outsource the portfolio construction and investing activities to a professional investment manager of your choice. And unlike managed funds where an investor owns units in a particular fund, the SMA account holder enjoys direct ownership of the underlying assets that make up their SMA portfolio.

The first step in setting up a SMA is to select a platform/WRAP provider to house your separately managed account. The next step is the hardest; deciding on which SMA investment manager you wish to use and which of their portfolio options you wish to employ for your account.

And there is no shortage of choice with hundreds of SMA investment managers and portfolios to choose from. There are many core ‘balanced’ portfolio options as well as specialised options in areas such as ethical investing or high dividend stocks.

Once you have decided your mix of SMA managers and portfolio options, you can then sit back and let the investment managers operate your account and make buy, sell and rebalance decisions on your behalf.

The SMA account holder benefits from individual tax treatment of the underlying investments and depending on the platform provider, you might also have the option to opt in and out of certain investments that the SMA investment manager wants to put into your portfolio, giving you some level of control over the investments.

No wonder they have become so popular: It all sounds great doesn’t it? But yes there is a catch – or rather a series of catches.

Indeed there is no ‘gotcha’ as such, but investors need to appreciate the trade off between convenience and cost. If you would like to outsource the management of your investment portfolio to a SMA manager, there is a fee attached to this. Most SMA investment managers charge a fee around 0.5 per cent per year.

In addition, to access a SMA structure you are likely going to have to set up a platform or WRAP account, which will charge an administration fee of approximately 0.5 per cent. Fortunately there have been several newer SMA platform providers that have come to market offering lower cost solutions.

Even if you pick one of the newer low cost SMA platforms, if your SMA investment manager decides that part of your money should be invested in an ETF or managed fund as part of your portfolio, you will also incur ETF and fund management fees. Index ETF managers can be as little as 0.03 per cent fees but as high as 1 per cent of more for actively managed ETFs. Fund manager fees typically vary between 0.8 per cent to 1.2 per cent.

With the three layers of fees in an SMA being the SMA provider, the SMA manager and the underlying ETF and fund manager fees, before you earn a cent from your SMA investments, your costs are likely to be between 1 to 2 per cent per year.

Financial advisers have also taken an interest in SMA’s as a way to outsource the investment management of their client portfolios. A report from SPDR ETFs / Investment Trends in March 2022 found that if a financial adviser stopped managing their clients money and instead outsourced it to a SMA manager, the financial adviser would save 15.7 hours per week on average in back office tasks.

With financial advisers moving in on the SMA space this introduces a fourth potential layer of fees, the financial adviser cost. And this particular cost needs to be carefully critiqued to make sure there is value being gained by the investors.

Some financial advisers will go through a thorough restructuring process and engage external asset consultants to become accredited as a SMA investment manager. This means that rather than the traditional way of contacting financial planning clients each time a change is needed on a portfolio and seeking their approval, the financial adviser will be able to make swift changes to multiple client portfolios at once via the SMA without seeking client approval to trade each time wearing the SMA manager hat.

Other financial advisers will simply appoint an external SMA manager and let them manage the portfolio, however they may still charge clients full financial advisory fees on top.

The question then becomes this: Are you comfortable paying a financial adviser who outsources the investment management responsibility to an external investment manager, who may then in turn outsource it to another investment manager, while all of them charge you fees?

If your financial adviser is providing you with advice outside of just investment management, then the answer is ‘maybe’ you can see value in the fee. But if your financial adviser is primarily engaged to manage your investments but then appoints someone else to do it, consider cutting out the middleman and go directly to the SMA investment manager. Otherwise, consider using a financial adviser who also has the accreditation as a SMA investment manager also so you are not doubling up on costs.

James Gerrard is principal and director of Sydney planning firm www.financialadvisor.com.au