Comparing Active Strategies

Foundations & Endowments

When not-for-profit institutions should leverage separately managed accounts vs mutual funds

The tremendous growth of separately managed accounts (SMAs) over the past decade has been extensively documented. As of the end of 2019, U.S. assets in SMA strategies had topped $1 trillion – an 84% increase from 2010 levels.1 According to Cerulli’s The State of U.S. Retail and Institutional Asset Management 2018, institutional assets apportioned to SMA strategies have been growing twice as fast as institutional mutual fund assets over the past decade.

For institutions like foundations and endowments, this widespread adoption of SMAs as vehicles to generate additional alpha through active management makes a tremendous amount of sense. There are several compelling inherent advantages to an SMA strategies when analyzed side-by-side with comparable mutual funds. But there are also one or two potential drawbacks that not-for-profit clients should also be aware of when considering investment choices.

5 key SMA advantages

Manager access – some high-profile or niche managers may only choose to work with institutions like foundations, endowments and pensions (as well as select UHNW individuals) and do not sub-advise 1940 Act mutual funds. This issue can be especially prevalent in asset classes where capacity is constrained due to market size or liquidity considerations. Similarly, there’s a whole universe of emerging managers (including minority- and female-owned firms) who may not have the asset base or extensive track-records to start a mutual fund, but have the ability to offer exposures that clients otherwise couldn’t access.

Investment flexibility – rather than a pooled investment vehicle like a mutual fund, organizations invested in an SMA own the holdings directly and in sole name rather than in a pooled format. As a result, SMA managers have the ability to provide a far greater degree of portfolio customization in adhering to a particular investment requirements or specific ESG mandate. And since they aren’t constrained by a tightly-defined and limiting prospectus mandates on sectors, asset classes and cash holdings, SMAs have a far greater ability to respond to evolving market and economic conditions.

Lower cost – because SMAs aren’t subject to the same regulatory reporting requirements as 40 Act funds, they’re able to eliminate an entire layer of fees related to the administrative expenses associated with fund accounting. This can translate into fee structures for SMAs that average around 30-50bps lower that comparable mutual funds.

Tax benefits – although taxes aren’t typically an area of significant concern for most foundations and endowments, on average SMAs generate better after-tax returns than mutual funds. Through the ability to harvest losses, they have the ability to generate on average an additional 50-80bps in after-tax returns. And because SMAs are portable, investors have the ability to shift strategy or change managers without having to selling all of the underlying securities held by a fund (which may trigger realized gains and transaction costs that may be reflected on financial reports).

Greater transparency – mutual fund managers report at the end of each quarter on their fund’s performance and holdings. Between those reports, however, you have little idea as to the manager is doing. This can lead to end of quarter ‘window dressing’ where a manager buys the quarter’s top performing investments to show them as portfolio holdings. Conversely, separate accounts offer full transparency and 24/7 insight into all your portfolio’s holdings, trades, and costs.

When funds may be a better fit

While the benefits of employing SMA strategies for the actively managed component of your portfolio are plentiful, there still remain certain instances and circumstances where traditional mutual fund structures will likely better address an organization’s investment needs and/or lead to better performance such as:

Enhanced liquidity – for certain asset classes such as fixed income or international equity, smaller not-for-profits may have relatively modest allocations and position sizes. In an SMA, this can lead to measurably higher transaction expenses due to frictional market costs. Such costs may not be readily apparent as they can arise within a wide bid to ask spread, and so are not transparent to the end client. In a commingled vehicle such as a mutual fund, however, investors almost always have access to low-cost liquidity. In certain rare instance a commingled fund can be made up almost exclusively of non-liquid securities, ordinarily that is a known factor at the time of investment and is factored into the planning for the overall portfolio.

Less implementation risk – Depending on account size and asset class, pooled funds can provide superior diversification relative to separately managed portfolios, especially where access to the underlying investments is limited to large block size or high minimum investment amounts.

Performance drag from rebalancing – Depending on asset class as well, and related to the liquidity concerns articulated above, rebalancing and portfolio management costs attributable to trading can be more efficient in a pooled format. In strategies that rely upon higher turnover trading approaches, the benefit of a pooled format can be material.

About Truist’s Foundations and Endowments Specialty Practice

With a 35-year singular focus on working with nonprofit organizations, fiduciary stewardship lies at the heart of our culture. We are not merely a provider for our clients; we are an invested partner, sharing responsibility for the prudent management of your assets. Our institutional teams include professionals with extensive nonprofit expertise, who are actively engaged in the community, and able to share best practices that are meaningful to your organization.

Our practice delivers comprehensive investment advisory, administration, planned giving, custody, trust and fiduciary services to over 1,100 not-for-profits, and we administer more than $32 billion in assets for trade associations, educational institutions, foundations, endowments and other nonprofit clients.2

Have questions about comparing active strategies?

Contact your Truist relationship manager or investment advisor or call us at 866-223-1499.