Myths and preconceived notions can rob your clients of extraordinary benefits.
Not so long ago everyone knew the earth was flat and at the center of the universe. Lightning never struck the same place twice. Touching a toad caused warts and you always had to wait an hour after eating before swimming. At one time all of these beliefs were held as true, until reason or an advance in scientific knowledge exposed the fallacy of these convictions.
Some of us unwittingly nurture our own sets of myths. While money may not grow on trees, given the amount of misinformation circulating in and around separately managed accounts, we might be given to seriously reconsider the dubious connection between forestry and cash.
Whenever an advisor provides incomplete information about oft-misunderstood SMAs, clients are then left to their own devices to conjure up visions of what these vehicles are. These would include tax-free, high-performing, low-minimum, custom portfolios, each personally run by the presidents of institutional money management firms. In other words, myths-by any stretch of the imagination.
Clearly, the benefits of managed accounts are aggressively marketed by their creators and promoters. Books, brochures, training seminars, Web sites, value-added educational programs and tools are all readily available. Even so, client-centric advisors with the best intentions may not be providing their clients with the most accurate information about SMAs. Consequently, more clients are quizzing their advisors about the differences between these individual accounts, and other products such as mutual funds.
There are numerous misconceptions about separate accounts, and one of these myths surrounds the idea of tax efficiency. So much can be done, for instance, with the newer structures of managed account products such as MDA-type accounts (multiple strategies), which focus on providing tax-efficient techniques. Overlay portfolio managers (OPMs) have the ability to manage tax liability across a variety of manager styles, with the bonus of also guarding against overlap of security positions and facilitating better diversification. SMA tax efficiency may be mislabeled as a myth simply because some advisors and their clients fail to take advantage of specific management features these accounts offer. Or because either they don't understand it themselves, or are not explaining it properly. This is where some basic talking points are helpful. Let's explore a few popular misconceptions clients may have, and help clear them up.
Myth Or Reality: Managed Accounts Are (Always) Tax Efficient
Reality. According to Gregory Gloeckner, president of Eastern Point Advisors, the advisory subsidiary of Investors Capital Holdings in Lynnfield, Mass., "The answer in general is 'yes.' However, if the manager is not managing the portfolio with tax efficiency as a goal, the portfolio will not necessarily have a better after-tax result."
The important point is that with separately managed accounts, the advisor and the client have the possibility to better manage the client's tax liability. Says Alan Sislen, SMA pioneer, president of Managed Account Perspectives LLC and former director of Merrill Lynch's Investment Consulting Group, "If a client has a specific tax situation one year and needs to take gains, but has a different tax situation the next year and would prefer to take losses, he or she has the ability to go through their managers to take advantage of that strategy."
Sislen explains that every client situation is different and the fact
that an advisor and a client don't take advantage of this benefit (or
don't need it that year) doesn't negate it. "The myth is propagated,"
he says, " because so few clients actually take advantage of it.
But the point is that the client has the benefit available. The benefit
may not be of any use for the client four out of ten years, but in
those years that it provides an advantage, the benefit can be
"This tax thing is pretty cut and dry," says Jim Owen, a partner in Austin Capital Management in Austin, Texas, and co-founder and chairman emeritus of IMCA. "Mutual funds are notoriously tax-inefficient, as we know. Typically there is very high account turnover, lots of trading activity. If you're [talking to] a portfolio manager for a mutual fund he or she will tell you, 'My job is not to be tax efficient; my job is to produce returns. Unlike hedge funds I can't use leverage and I can't sell short.' The imbedded taxes are real serious issues for investors."
Myth Or Reality: Managed Accounts Offer A High Level Of Customization
Reality. Again, the myth that customization is just hype is kept alive by clients and their advisors who don't take full advantage of this feature of managed accounts. Customization relative to these accounts involves restricting certain types of investments-so-called 'sin' stocks, like tobacco or alcohol-or limiting investments to stocks of socially or environmentally conscious companies. "The client, through the advisor, can restrict certain securities so that the manager does not buy them for that particular client," explains Sislen.
The customization of the portfolio and the ability for the client to restrict certain types of securities is often underutilized. "I haven't seen any hard numbers on this, but anecdotally, my experience says that somewhere between 10% and 20% of SMA clients use this capability. Other industry sources have reported 25% or more," he adds.