Are Separate Accounts Right For You?

BY DONALD JAY KORN

FOR INVESTOR'S BUSINESS DAILY

Posted 8/3/2007

http://www.investors.com/editorial/IBDArticles.asp?artsec=19&issue=20070803

More investors are choosing separately managed accounts for at least part of their investments. But are they right for you?

SMA assets topped $900 billion at the end of the first quarter, according to the Money Management Institute. That's more than double the level of year-end 2002. More than two million investors have SMAs.

Separately managed accounts mix the strengths of investing in securities directly and, alternatively, of investing in mutual funds.

SMAs offer the diversification and professional securities selection of funds. Yet you have the flexibility and control you get with individual stocks and bonds.

They are most helpful to investors who can't commit the time and effort to selecting their own stocks, bonds and funds.

Like any strategy, there are pros and cons. To decide if they're right for you, you must know how SMAs work.

You start by meeting with your broker or other financial adviser. An adviser can work for a big financial firm like a major brokerage or a smaller independent outfit.

He'll ask you questions about your goals, risk tolerance, and so on. From your responses, he'll help you choose an asset allocation.

Your target portfolio might be 15% large-cap value stocks, 15% large-cap growth stocks, 10% mid-caps, 20% foreign stocks, and so on.

For each asset class, your adviser will suggest one or more money managers.

He culls those nominees from a roster kept by a sponsor, which can be a big brokerage.

Typically, managers are recommended because they have beaten benchmarks in an asset class in a given time period.

Say a hypothetical John Smith has a $500,000 portfolio and a 15% allocation to large-cap value stocks. A well-regarded value stock manager will invest $75,000 of Smith's money in selected large caps.

Other managers will do the same for other asset classes.

So investing in an SMA means that you have an asset allocation designed by a professional adviser and a portfolio of stocks picked by proven money managers.

You won't have to do your own stock selection. Mutual funds and other pooled investments also offer these benefits.

Control Factor

"But one difference is control," said Lewis Walker, a financial planner in Norcross, Ga. With SMAs, you own individual stocks rather than a basket of stocks.

You can give your managers free rein to trade without checking in with you. You also can retain a say in what is bought and when they're sold. You can veto portfolio recommendations.

You can tell your adviser in advance to select or avoid certain stocks. You might feel it's wrong to own tobacco shares, for example.

Or you might work for a major pharmaceutical firm and own lots of company stock. You could instruct your adviser to exclude drug manufacturers from your portfolio and put more into other sectors.

Your adviser passes your wishes on to the money managers picking stocks for you.

A similar process takes place on the sell side. You can instruct your adviser to take losses. That can offset capital gains.

Or you can say you would like to take gains, if you have a capital loss to use up.

So you control your tax position. "Your tax bill won't depend on the tactics of a fund manager you can't control," Walker said.

Some mutual fund categories might be hard to access. Many top small-cap funds are closed, for instance.

SMAs can enable you to get into these asset classes with experienced managers.

Some Drawbacks

But SMAs can have drawbacks.

• Cost. Investors generally pay fees that total from 1.5% to 3% per year of the assets in the account. The more money being managed, the lower the percentage.

Boosters say there are benefits to this arrangement. Investors don't have to pay commissions. So there is less risk that your broker will encourage trading just to line his pockets.

And your adviser can have an incentive to see your portfolio grow. That usually means he gets bigger fees.

But fees can be steep. On a $500,000 portfolio, they might range from $7,500 to $15,000 a year.

You might not pay that much in sales commissions if you trade your portfolio modestly.

• Competency. Just because your stocks are being chosen by a money manager who has performed well in the past, that does not assure future success.

• Customization. SMAs may be available to investors with as little as $25,000. But at that level, you can't expect the same attention to asset allocation, stock picking and tax planning as someone with a $250,000 or a $2.5 million account. It's uncertain whether every SMA program will live up to its promises.

• Complexity. You may own hundreds of stocks outright in an SMA program. Keeping track of all the periodic reports may be hard.