Separately managed accounts suit everyone except the investor

Touted as an efficient way to leverage professional investment managers, the apparent advantages of trendy Separately Managed Accounts crumble under close inspection.

Investors are promised more control with Separately Managed Accounts, but there are more costs too. Picture: NCA NewsWire / Damian Shaw

Separately Managed Accounts (SMAs) are becoming an increasingly popular way to manage money for private investors as they allow financial advisers to use external investment managers who oversee the investing activities of their client portfolios.

The take up has been strong: A 35 per cent increase from $80.6bn in December 2022 to $108.8bn in December 2023 from an Institute of Managed Account Professionals census that collected data from 46 firms who used SMAs.

Touted as a way to create efficiency in a financial advice practice by leveraging the expertise of professional investment managers, the question must be asked - who is the ultimate winner of a SMA, is it you as the client or your financial adviser?

For those not familiar with how a SMA works, it is simply an investment account that is typically made up of individual stocks, ETFs and managed funds. The SMA manager is appointed to make buy and sell decisions in line with the agreed SMA strategy.

There are hundreds of off-the-shelf SMA investment portfolios available in Australia from dozens of professional investment managers and the role of the financial adviser is to match their client with the right SMA manager and the right SMA investment portfolio. Some SMA portfolios target high income, while others concentrate on ethically focused portfolios.

It does sound great in theory, your financial adviser uses their expertise to select a SMA manager and a SMA investment portfolio for you. And after this has been put into place, they will monitor the SMA manager and switch you into another SMA manager if things do not go to plan.

Your financial adviser is now freed up from the heavy responsibility of having to research, trade and manage your investment portfolio and can now focus on more valuable “strategic outcomes” such as cash flow management and estate planning.

But in practice, SMA’s are one of the best kept secrets in the world of financial services - for all the wrong reasons.

While it is certainly true that a financial adviser is unburdened from the responsibility of having to invest your money, it begs the question as to what you are actually paying for?

Let’s face it – what’s more important for an investor than making money and protecting your wealth? For most people, the primary purpose of using a financial adviser is to have them invest successful while compliance and everything else is secondary to the professional investment management service.

So if you are engaging a financial adviser on the basis that their main value is to invest your money, and the financial adviser subsequently recommends a SMA portfolio, you should think very carefully about whether it is really worth paying thousands of dollars each year for that?

For starters, the fees charged in an SMA can be very high. You have the financial adviser fee, the SMA manager fee, the ETF manager or fund manager fee and finally the platform fee. Four layers of fees create a lot of mouths to feed and require several per cent return each year just to break even.

While there is no issue with a financial advisory firm outsourcing the investment management decisions via a SMA process if they believe a larger specialised investment firm could do a better job: The problems arise when financial advisers are still charging the same level of fees but require less in-house staff under a SMA and are pocketing the extra profit.

Consider the situation of a typical 70-year-old retiree. Their estate plans are likely in place, they know how much they spend on a regular basis and do not need cash flow and budgeting advice, they have done all they can to optimise tax, typically by holding the majority of their retirement nest egg in superannuation and they have already established their Centrelink entitlements.

Outside of investing money in line with their risk profile and retirement objectives, there is not a lot of value the financial adviser can add in this situation.

Everything in the client’s life is catered for and the only thing the financial adviser can do is assist in generating income while trying to protect capital from the ups and downs of the share market.

Unfortunately there are too many investors who use SMAs and are not getting what they think they are paying for. If asked, they probably would not be able to explain the mechanics of their SMA but trust that their financial adviser has their best interests at heart and must have a valid reason for shuffling them into such a structure

But in the worst cases, little do they know that the financial adviser has washed their hands of the investment management responsibility and is simply there to clip the ticket.

Clients with a SMA need to ask the tough questions to their financial adviser and get to the bottom of what they are really paying for.

If the primary purpose is to invest your money and that is being outsourced to a SMA manager who also charges you a fee, it might be is time to consider cutting out the middleman and go direct to the SMA manager or do it yourself and invest in a low cost diversified portfolio underpinned by ETFs.

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