THE DRAWBACKS While there are a number of strong attractions and advantages to SMA and IMA portfolios, there are also a number of potential drawbacks to be conscious of. Lower quality managers The availability and accessibility of a number of SMA and IMA portfolio administrators has opened the market for new and/or small, less reputable portfolio managers to manage direct equities portfolios as a way to generate investment management fees based on funds under management. The barriers to entry are much lower for SMA and IMA managers than for managers of managed funds. As a result, as in all cases, it is important to select an SMA/IMA manager that has a strong track record, is well resourced, has an experienced investment team and has a defined and robust investment process. The universe of fund managers managing SMA and IMA portfolios is significantly smaller than that managing managed funds.
Inexperienced SMA/IMA managers As an extension of the above point, it is important to select a manager who is experienced in the management of SMA/IMA portfolios, as it requires a different approach from managing a managed fund. In our experience we have seen successful, reputable fund managers manage SMA portfolios in the same way as their managed funds, which is usually disastrous, as high levels of portfolio turnover can generate high transaction costs and tax implications for investors. Different returns Investors often expect the returns from their SMA portfolio to be the same as, if not similar to, returns from the manager’s equivalent managed fund. This is never the case, due to portfolio differences, trading frequencies, trading costs and transaction trading rules. In many instances this can lead to an underperformance of the SMA portfolio compared to the managed fund (particularly before tax). Investors should not expect returns of an SMA to be identical to the same fund manager’s managed fund.
New floats and corporate actions Many investors like investing in direct equities via a broker for access to new floats and the chance to make stag profits. In SMA portfolios, the portfolio manager determines which stocks they will invest in and it is usually the portfolio administrator that has the relationship with the brokers when transacting the portfolio. As a result, the individual investor’s payment of brokerage is not recognised by the underlying broker, and therefore those investors are not given priority access to floats. In addition, decisions concerning corporate actions (rights issues, bonus shares and so on) are determined by the portfolio manager, and therefore the SMA investor’s portfolio will reflect the manager’s decision. This may differ with IMA managers, where some may consult the investor as to their individual preference. The recent trend to direct equities has driven many advisers to seek more efficient, properly managed direct equities alternatives. However, it is important that both advisers and investors fully understand what they are getting into, including the features and some of the potential drawbacks of these investment structures.
