Managed Accounts vs. Mutual Funds

Mutual Fund Article

Charles Schwab & Co., Inc.

Call us at 866-232-9890

Send us an email

Printer-friendly
Type Size: A A A
Email to a friend

Managed Accounts vs. Mutual Funds
by the Schwab Center for Financial Research
March 20, 2008

Reprinted from the February 2008 issue of Schwab Investing Insights®, a monthly publication for Schwab clients.

Americans have more than $12 trillion invested in mutual funds, which offer a convenient way of accessing some of the best professional money managers by asset class. Owned by 55 million households—roughly half of all in the United States—mutual funds can typically be used by even the smallest investors, and are prevalent in retirement accounts, such as 401(k) plans.¹

But for investors with more complicated wealth circumstances and preferences, an increasingly accessible, more comprehensive investment solution has emerged—separately managed accounts. With around $2 trillion currently invested in managed accounts, their popularity is growing.² Indeed, managed account assets are expected to reach $3.4 trillion by 2011.³

Why now? Managed accounts have been growing in popularity due to operational efficiencies allowing more firms to offer them. And in the last decade, fees and investment minimums have decreased enough to allow the modestly wealthy access to the same managers and benefits that ultra-wealthy investors have enjoyed for years.

What is a managed account? Ownership has its privileges
Mutual funds and managed accounts are essentially the same thing: professionally managed portfolios that offer exposure to stocks, bonds or other securities. There are many distinctions between the two, but the most important is what you actually own. In a mutual fund, you own shares of a pool of securities with other investors. In a managed account, you own the underlying portfolio of securities, whether stocks or bonds.

While this difference in ownership may seem trivial at first, it enables some of the key investor benefits, such as greater control over taxes and customization. Now we'll look at three benefits this sophisticated structure of managed accounts offers versus mutual funds:

Greater control over taxes. Although some mutual funds have tax-efficient investment strategies, they can fall short compared to managed accounts. As a fund investor, you can control when you buy and sell shares of a fund for a gain or loss, but you cannot control what the fund manager does to the portfolio. Mutual funds must distribute at least 90% of their realized capital gains and dividend income to shareholders annually, so you may receive unwanted tax gains.

You won't avoid realized gains and income distributions entirely in managed accounts; however, because you own the underlying holdings, you can direct your portfolio manager to harvest losses in individual securities to offset some of your gains. Admittedly, this requires some work on your part, tracking gains and losses and coordinating with your Schwab consultant and portfolio manager. But the effort can pay off: You may improve your after-tax performance as well as alleviate lurking tax issues in other parts of your portfolio, such as reducing capital gains from stocks sold or offsetting mutual fund distributions.

One final way in which managed accounts can be more tax-friendly than mutual funds is how you fund your account. Here's an example: Let's say you own low-cost-basis Microsoft stock and are considering a large-growth mutual fund and a large-growth managed account, both of which invest in Microsoft. To buy the fund, you could sell Microsoft to raise cash, incur a taxable gain, then end up with shares of a fund invested in Microsoft. With the managed account, you could move all (or part) of your Microsoft stock into your new account, incurring no (or a reduced) taxable gain. And moving securities out of a managed account can be just as easy: Your manager can help you with charitable gifts of the underlying securities or an in-kind transfer to another account.
Customizable portfolios. Managers of separately managed accounts may apply a common investment philosophy for a large base of clients; however, a greater degree of customization is possible because you own the underlying securities.

When would you need this? Imagine if you hold a lot of your company's stock in your 401(k), and you know that your company is within your separate account manager's chosen strategy. You can direct your manager to exclude your company stock or its industry to avoid exacerbating your concentrated position. Or you may want a portfolio based on socially responsible criteria, green investing or even the right to vote company proxies.
Transparency of holdings and trades. Mutual funds are only required to report holdings semiannually, so you may find information on your fund's holdings to be stale. Frequently, you may not know which securities you're exposed to in the fund or what changes a manager has made until you get the semiannual report. Managed accounts, on the other hand, offer highly engaged investors up-to-date online account access, including underlying positions, portfolio activity and asset allocation.

Other factors to look at before deciding
If these benefits sound appealing, consider these four additional factors that can help you determine if mutual funds or managed accounts are more appropriate for you. And check out the comparison table below.

Minimum investment. You can invest as little as $100 in a mutual fund, depending on the fund company, share class and account registration. However, managed accounts are designed for more affluent investors: At Schwab, the minimum managed account investment starts at $100,000 for equities and $250,000 for fixed income. To build a portfolio exclusively from managed accounts, you'd need a relatively large asset base to be adequately diversified across and within asset classes.
Fee structure. Mutual fund investors pay an annual operating expense ratio, which varies by fund. This expense ratio includes management fees, administrative expenses and any marketing fees (known as 12b-1 fees). It does not include trading costs of the fund (which directly impact the fund's price), transaction and account custody charges or performance reporting. Although a fund may offer an institutional share class with lower fees, most share classes of a fund basically offer the same expense ratio no matter how large the investment in that fund.

At Schwab, managed account fees are bundled to include trading costs, custody and management fees, performance reporting and investment consultation. While total mutual fund expenses (with hidden transaction costs) can be competitive with managed account fees, the main difference is the scalability of these fees: the greater the amount you invest, the lower your cost (as a percentage of assets).
Complexity. It's more complicated to open, fund and close managed accounts than mutual fund accounts.
Investment choice. While most managed account programs offer a diverse menu of strategies and exposures, investors may find limited choices in more specialized actively managed categories. For international or emerging market debt, high-yield bonds and sector- or industry-specific equities, mutual funds may be the better choice. Particular operational aspects of these strategies (such as trading local securities in foreign markets) make them difficult to offer in a managed account.

Managed Accounts vs. Mutual Funds: Compare Your Options
If you want:	Separately Managed Accounts	Mutual Funds
Professional management	Yes	Yes
Ownership of underlying securities	Yes, and can direct proxy voting rights if desired	No, own shares of the pool of securities
Portfolio transparency	Holdings and transactions available online daily	Holdings available with a lag semiannually, perhaps quarterly
Control over capital gains and losses	Yes, can direct manager to take losses to offset gains	No, can only control gain or loss by selling fund shares
Customization of portfolio contents	Yes, on a security and industry level	No
Portability of underlying holdings	Yes, in and out of the account	No
Quick withdrawal or liquidation	Three to five days	Next day
Other features you may want to consider:
Minimum investment	$100,000 for equities, $250,000 for fixed income	Varies, from $100 for Schwab Funds® to $250 for others
Fee structure	Tiered, asset-based fee (includes trading, management, custody, investment consultation and performance reporting)	Asset-based fee (plus trading, custody, transaction and sales fees, if applicable)
Choices available	Diversified list of strategies, but fewer opportunities in specialized asset classes	Very wide range of choices, including specialized asset classes
How to invest	With cash and securities	With cash only
Reporting	Trade confirmations, monthly statements and quarterly performance reports	Quarterly statements, semiannual prospectus
Service	Personalized service and communication with investment personnel, initial consultation before investing	Access to shareholder services and operational support, clients can invest without any consultation

Source: Schwab Center for Financial Research, based on investing in separately managed accounts with Charles Schwab & Co., Inc.

Not all managers are available in both vehicles
Mutual funds and managed accounts both offer access to some of the most talented and skilled managers in the business. Although most management firms will offer both a mutual fund and a managed account for a particular strategy, sometimes it can be just one or the other. Bill Gross, one of the country's best-loved bond managers, offers his signature fixed income strategy PIMCO Total Return in a mutual fund (PTTDX) and a managed account. Tom Marsico, a well-known growth stock picker, similarly offers his Marsico large-growth fund in a mutual fund (MGRIX) and a managed account.

On the other hand, Neuberger Berman's "Team Kaminsky," with frequent CNBC guest Gary Kaminsky, runs an all-cap core managed account (currently closed to new investors) but no all-cap mutual fund. And the only way to invest in the Bridgeway Blue-Chip 35 Index, managed by quantitative stock-picker John Montgomery, is through Bridgeway's mutual fund (BRLIX).

What's right for you?
Managed accounts can be a powerful tool for affluent investors willing to shoulder additional responsibilities to capitalize on tax management and customization benefits. They share some features with mutual funds, but depending on asset levels and customization needs, one option may make more sense than the other for you.

For beginning investors, mutual funds are a good way to start building wealth (particularly with an automatic investment program), whereas managed accounts offer more sophisticated solutions for investors with more money to invest and complex investment needs. Not surprisingly, Schwab consultants believe a well-diversified combination of managed accounts, mutual funds and other securities is the right solution for many investors.

Long-term investors have a variety of choices using professional management. When considering separately managed accounts, mutual funds or fund portfolios such as Schwab Managed Portfolios™, ask your Schwab consultant which solution—or combination—is best for you.

1. Source: Investment Company Institute. Assets as of December 31, 2007, and ownership from 2007 Investment Company Fact Book.
2. Source: Cerulli Associates, as of September 30, 2007.
3. Source: Cerulli Associates, Managed Accounts 2007 Update.

Important Disclosures

Investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.

Past performance is no guarantee of future results, and your investment value and return will fluctuate such that shares, when redeemed, may be worth more or less than original cost. See Schwab.com for more recent performance.

Investments in managed accounts should be considered in view of a larger, more diversified investment portfolio. Please read Schwab's Schedule H of Form ADV for important information and disclosures relating to Schwab Managed Account Services™. Services may vary depending on which money managers you choose, and are subject to a money manager's acceptance of the account.

Periodic investment plans such as dollar-cost averaging and automatic investment plans do not assure a profit and do not protect against loss in declining markets.

This report is for informational purposes only and is not an offer, solicitation or recommendation that any particular investor should purchase or sell any particular security or pursue a particular investment strategy. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Past results are not indicative of future performance. Examples provided are for illustrative purposes only and are not representative of intended results that a client should expect to achieve.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

(0308-3965)

Return to Top

Learn how Schwab can help

Schwab Managed Portfolios

Expert Fund Picks

Complimentary Consultations

Market Insight Alert Email

New Schwab commentary every two weeks:

Monday: Liz Ann Sonders
Thursday: Schwab Sector Views
Friday: Schwab Market Perspective

Clients can sign up now