The growth of separately managed accounts is providing retail investors with more customized investment options amid volatile market conditions.
Ed Paulinski, portfolio manager and head of municipal SMAs at Goldman Sachs Asset Management, said the marketplace offers a multitude of solutions for clients as there is never a one-size-fits-all approach.
Paulinski believes 2022 may be a turning point in how SMAs are viewed in the context of an individual’s asset allocation.
Investors looking for immediate exposure to the market or to invest in assets that exhibit higher risks may find it more appropriate to own a co-mingled product, such as a mutual fund. In fixed income, purchasing a mutual fund or exchange-traded fund when yields are relatively low enables the client to gain access to a seasoned portfolio that was invested over a longer time horizon.
For investors that want a customized portfolio and a greater ability to control taxable events, SMAs may be a more suitable product, he said.
SMAs are uniquely positioned to capture rising investor demand, Paulinski said. Investors want portfolios that are tax-efficient, meet their specific risk tolerances and align with their personal goals.
This goal-driven investing, partially fueled by a new generation of wealth creators, has contributed to the evolution of SMA strategies over the past several years, he said.
SMA assets under management have been growing steadily for the past decade, according to Tom Doe, president of Municipal Market Analytics.
Municipal SMAs have grown from $139.3 billion in the fourth quarter of 2017 to $257.7 billion at the end of the third quarter of 2021, according to Cerulli Associates.
“Volatility is not liked by any investor, so any efforts to mitigate creates stability of assets,” he said.
SMAs are considered a good alternative in the face of market conditions, like rising interest rates and poor market technicals.
For instance, the projected Federal Reserve rate hikes in 2022 have contributed to individuals’ withdrawing from mutual funds, whose declining net asset values exert a greater negative psychology than an individual bond’s evaluation decline, Doe said.
“It is possible that mutual fund complexes are looking for stickier assets and thus the SMA route provides that potential,” he added. At the same time, “
However, the SMA approach provides more customization and credit monitoring that enables justification of fees, according to Doe.
“Investors with SMAs tend to emotionally focus on income rather than daily value of assets under management,” he said.
Anthony Valeri, director of investment management at Zions Wealth Management in San Diego, said investors want more performance from their securities but less risk, so SMAs fit the bill for many investors.
“I think it's a desire by investors to hold individual securities — whether they are stock or bonds — and I think mutual funds and ETFs are not sexy enough for them,” Valeri said.
SMAs offer a little more customized strategy, more flexibility in tax-loss harvesting and more efficiency with taxes for retail investors, especially municipal SMAs.
“Ultimately what municipal investors should look at is the sensitivity and quality of their portfolios,” Valeri said.
However, owning SMAs does have its risks.
For instance, SMAs could suffer a drop in liquidity if they are small and hold bonds in smaller denominations, compared to mutual funds or ETFs that have greater market coverage, hold more securities, and are more diverse, he said.
“With SMAs, investors need a larger dollar amount to get that diversity,” Valeri said.
In addition, many SMAs are geared toward short and intermediate bonds to match retail investor demand, so they could provide slightly less market coverage and balance, according to Valeri.
“Investors should be cautious because in the context of a broader portfolio they have to make sure they are diversified in the municipal market — and not too heavy on short and intermediate bonds,” he said.
High-yield is one area, Valeri said, that can’t be covered by an SMA.
“Once you get to below investment-grade, there is not enough liquidity to include high-yield in an SMA, so that’s where the big buying power of an ETF and mutual fund is advantageous,” he said.
SMA growth prompted the firm to
“Municipals have grown to represent the second-largest manager-traded asset class offered through separately managed accounts and remain a significant contributor to gross and net flows within the industry across distribution channels,” Ben Barber, senior vice president and director of municipal bonds at Franklin Templeton, told The Bond Buyer after Nemerever's hiring.
The creation of Nemerever’s role reflects Franklin Templeton’s commitment to its overall SMA strategy and aligns resources equivalent to the significant demand the firm sees from investors seeking diversification, lower volatility, and tax-exemption benefits offered through municipal SMA portfolios, Barber said.
In addition, the current market conditions make SMAs attractive for retail investors — and allow them an entry point into municipal bonds — as they tend to perform better in a rising-rate environment because tax-exemption becomes more attractive as rates climb, he said.
For the first time since 2018, a rising-rate environment is also making fixed-income more attractive to individual investors.
During periods of rising rates, investments in individual securities are better able to take advantage of market dynamics. As markets evolve and become more efficient, Goldman's Paulinksi said, there is also a tendency to transition brokerage portfolios to professionally managed SMAs.
“A demand for personalized investing, combined with accessible investment options, against a backdrop of favorable market yields could lead to a trifecta for growth in the upcoming year,” he said.
Additionally, the significant repricing in rates over the past few months has created opportunities that fixed-income investors have not witnessed in quite some time, Paulinski said.
“If the market environment remains conducive enough for those customizations to be actionable, at ‘attractive’ valuations, these dynamics all point toward a promising year of growth,” he added.
SMAs offer investors flexibility and an alternative to individual bonds and, more recently, credit assistance and support during the pandemic.
Sylvia Yeh, co-head of municipal fixed income at Goldman Sachs, said it’s not about selling product. "It's about determining the right solutions for them," Yeh said at The Bond Buyer’s National Outlook conference in early March. "Clients want something personal for them. It’s not a one-size-fits-all thing anymore and that's why you're going to continue to see SMAs grow."
Over the past few years the market has changed, she said, and SMAs are the best of brokerage management assets.
“The neat thing about SMAs is we can be patient, we can be flexible," she said. "There are always phone calls that we can make. You don't see that type of power in the mutual fund complex or ETF complex and better.”
Different strategies can help investors achieve their personal financial objectives, according to Matthew Gastall, executive director and head of wealth management municipal research and strategy at Morgan Stanley.
“Individual bonds allow investors to tailor their accounts to their own risk tolerances and preferences, and participants can also take advantage of opportunities that may surface when broader selling occurs,” Gastall said. “These were apparent in 2010, 2013, 2016, and during the onset of the pandemic.”
SMAs are a managed alternative and, more recently, some investors have been willing to remunerate for additional credit support, especially during the pandemic.
“Since the pandemic, some clients have wanted more credit assistance, so they chose a managed approach like SMAs,” Gastall said.
However, ultimate adoption will most likely depend on market stability as investors may prefer to have further near-term confidence in asset-class return expectations before making any significant changes to their portfolios.
The municipal SMA industry increase has yet to plateau. “I think SMA growth has been around for a while — and is here to stay — because of the continued desire to own individual securities,” Valeri said.
