Fiduciary Split Decision - Are Separately Managed Accounts (SMA) in the Best Interest of 401k Savers

Fiduciary Split Decision - Are Separately Managed Accounts (SMA) in the Best Interest of 401k Savers

June 01, 2024

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Fiduciary Split Decision - Are Separately Managed Accounts (SMA) in the Best Interest of 401k Retirement Savers
by Christopher Carosa August 01, 2023

Recently, Cerulli Associates hosted an online webinar on The Future of Customization in Asset Management. It featured Shawn O’Brien, director of Retirement and Matt Belnap, associate director of U.S. Managed Accounts. The two offered an update on recent fiduciary trends and where those trends might be heading.

Belnap said that while they’ve seen a 2-3% increase in the share of adviser managed assets per year, the fiduciary portion outstripped the non-fiduciary segment by as much as 5% per year. He said that, in the past, advisers could stand out by being fiduciaries. It was a way to differentiate.

Now, however, Belnap warns not only is everyone saying they are a fiduciary, there are almost too many ways to consume “fiduciary.” “There are a lot of different advisers, a lot of different channels,” he says. “Being a fiduciary isn’t necessarily a way for us to differentiate anymore.”

To stand out in the future, says Belnap, advisers are increasingly looking at ways to offer advanced personalization as a way to differentiate.

While Belnap was speaking from the retail end, O’Brien looked at the issue from the retirement side. Focusing on the participant level—as opposed to the plan level—of fiduciary, he said that recordkeepers don’t want to act as fiduciaries. He pointed out that advisers do want to serve as participant-level fiduciaries and do it through Advisor Managed Accounts (“AMAs”).

These, he said, represent the next step beyond automatic and default features in 401k plans. Automatic and default features successfully got disengaged employees to save in their 401k. AMAs will take retirement services to the next level.

“Participants can benefit from something that is not just completely automatic and default driven,” says O’Brien. “They can benefit from something more tailored to their unique circumstances, particularly as they are approaching certain key inflection points in their working lives or key financial decisions they have to make or key life events. Therefore, what we’ve been seeing in the retirement plan industry is this emphasis on retirement plan services.”

Why is this important? O’Brien explains, “Over time, participants accumulate assets and differences.” It’s OK for everyone to ride in the same bus when they’re just getting started in their careers. As they get older, he says, their needs and circumstances change. This makes it more difficult for “one-size-fits-all” solutions.

He likens this to an evolution of sorts. Retirement savers start off using traditional TDFs, then move towards AMAs, before finally graduating to the traditional holistic wealth management service.

Indeed, on the retail side, Belnap expects Separately Managed Accounts (“SMAs”) to outgrow both the mutual fund and the ETF side of the business as investors seek more personalized attention to their investments. He sees two reasons for this. First, more than half of the advisers aren’t using SMAs, so there’s an untapped opportunity there. Second, platform providers listed “Direct Index Separate Accounts” as the most attractive option to add to their platforms.

In speaking with practitioners, Cerulli’s analysis receives a mixed reaction.

“They are correct because the benefits to the client using an SMA platform are manifold compared to the traditional mutual fund or ETF design, both in cost of ownership and performance,” says Richard Bavetz, investment advisor at Carington Financial in Westlake Village, California. “The adviser can more easily provide consistent risk management, meaningful diversification, and opportunistic allocation, all of which benefit the client and will naturally attract clients as they learn and hear more about SMA’s.”

But not everyone agrees.

“The next gimmick: SMA,” says Lawrence (Larry) Starr, Vice President at Cornerstone Retirement, Inc./Qualified Plan Consultants in West Springfield, Massachusetts. “As if those advisers offering such a program have any hope of beating the market (after their costs); but it ‘sounds good.’ More like rearranging the deck chairs on the Titanic. They can’t beat the market now with their managed accounts; why would SMAs make any difference? Just a new ‘feel good’ approach.”

The sense that, as retirement savers age, there is a sense that personalization will become increasingly important.

“401k plans are increasingly seen as the primary retirement plan for most participants,” says Andy Larson, Director of Retirement Education at Retirement Learning Center in Brainerd, Minnesota. “This means a more defined benefit like approach to setting retirement goals, investment approaches, and feedback loops. SMAs are well suited to meet these needs.”

In the end, the question comes down to how—or if—retirement savers can benefit. Are SMAs in retirement savers’ best interests?

“They are not!” says Starr. “Because SMAs offer ‘customized portfolio management,’ the myth is that the advisors can do better than they can with plain old mutual funds. Still, all the data shows that advisors that provide account management still don’t beat the S&P 500 over a reasonably short period of time. But most important: SMAs make little sense in qualified plans. From Investopedia: One of the most significant benefits of separate accounts involves tax gain/loss harvesting, which is a technique for minimizing capital gains tax liability through the selective realization of gains and losses in your separate account portfolio. That is of no value to a retirement plan. And for that, the client will be paying much, much higher fees than, say Vanguard would charge for the S&P 500 index fund.”

Again, there is more than one point of view on this.

“In particular, direct ownership offered by an SMA increases efficiency by reducing unnecessary costs and expenses,” says Bavetz. “In addition, there is meaningful diversification, whereby an overlap of holdings that typically exists across multiple mutual funds and ETFs can be avoided. The client under the care of their fiduciary adviser, has greater control of what they own and how long they own it.”

One way to look at SMAs is how they might be viewed as personalized pension plans. Larson says, “SMAs fit into a more defined benefit like approach where a retirement date and income goals are established, and the investment process is essentially the same—albeit at a smaller scale—as the investing and funding process for defined benefit plans.”

That being said, even Cerulli says SMAs aren’t for everyone. They say that an asset size of between $500,000 and $2,000,000 represents the sweet spot for those most able to benefit from SMAs.

The most interesting thing about this phenomenon is that it appears to be reversing the trend toward mutual funds that began three decades ago.

Christopher Carosa is an award-winning online news producer and journalist. A dynamic speaker, he’s the author of 401(k) Fiduciary Solutions, Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort, From Cradle to Retirement: The Child IRA, and several other books.