Converting SMAs to ETFs—Unlocking the Full Value of Your Client’s SMA

Investing can often feel like navigating a complex maze, and managers have more investment product at their disposal than ever before. Open-end, closed-end, interval funds, tender offer funds, CITs, ETFs and Separately Managed Accounts (SMAs) to name a few. But among these options, Exchange Traded Funds (ETFs) have emerged as a popular and advantageous investment vehicle, and their unprecedented growth bears that out. While index-based ETFs have traditionally dominated the market, actively managed ETFs are gaining traction for their potential to deliver superior returns through skilled portfolio management. Let's explore why the actively managed ETF structure is beneficial and how converting Separately Managed Accounts (SMAs) into ETFs on a tax-deferred basis can enhance your clients' investment strategy.

The Benefits of Actively Managed ETFs

We all know that actively managed ETFs combine the best features of mutual funds and individual stocks, offering a unique blend of professional management, liquidity and cost-efficiency. Unlike index-based ETFs that passively track a specific index, actively managed ETFs employ portfolio managers to select and trade securities with the goal of outperforming the market. This active approach can lead to better performance, especially in volatile or inefficient markets where skilled managers can identify and capitalize on opportunities. On the other hand, SMAs offer a personalized investment approach, where a professional manager oversees a portfolio tailored to the investor's specific goals and preferences. While SMAs provide customization and direct ownership of securities, they can also come with higher fees and potential tax inefficiencies due to the frequency of trading. In addition, over time a client's SMA has a tendency to drift from an optimal allocation as unrealized taxable gains build and the client's tax costs outweigh the benefits of efficient rebalancing. By converting an SMA into an actively managed ETF, managers can address these challenges for their clients while the client retains the benefits of professional management and customization.

One of the most compelling reasons to convert an SMA into an ETF is the potential for tax deferral. When securities within an SMA are converted into an ETF, this process can often be done on a tax-deferred basis, meaning investors do not immediately incur capital gains taxes. This tax efficiency brings a significant advantage as it allows the portfolio to grow without the drag of annual tax liabilities. Additionally, the ETF structure inherently offers tax advantages due to the in-kind creation and redemption process, which can further enhance the after-tax returns for investors.

Another advantage of actively managed ETFs is their transparency. Unlike traditional mutual funds, which typically disclose their holdings quarterly, ETFs provide daily disclosure of their holdings, which allows the investor to see exactly what they own and understand the portfolio manager's strategy ultimately leading to better-informed investment decisions and greater confidence in the management team.

A Strategic Move for Modern Investors

In today's dynamic investment landscape, actively managed ETFs represent a strategic option that combines the benefits of professional management, liquidity and cost-efficiency that benefits both the manager and the investor. Converting your clients SMA into ETFs on a tax-deferred basis can provide significant advantages, including reduced fees, improved tax efficiency and continued professional management. By embracing the actively managed ETF structure, investors can optimize their portfolios for better performance and greater flexibility, ultimately paving the way for a more robust and resilient financial future. For managers, the conversion of an SMA to an actively managed ETFs provides them with the ability to manage the portfolio more freely and introduce tax efficiencies to their clients who may otherwise be looking at a portfolio constricted with tax implications.

For those who manage SMAs, considering a conversion to ETFs on a tax-deferred basis could be another lever to pull to unlock additional value for your client and help them achieve their long-term financial goals.

Reach out to learn how SS&C ALPS Advisors can help you unlock your clients' SMA in a smart and modern way.

Eric Hewitt,Chief Investment Officer, SS&C ALPS Advisors, contributed to this article.

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