SMAs vs. Funds: How do They Compare?

Mutual funds and exchange-traded funds (ETFs) have become ubiquitous in modern portfolios, offering professionally managed exposure to broadly diversified indexes and niche markets alike. But for investors with significant assets and nuanced financial needs, the one-size-fits-all nature of such funds may leave something to be desired in terms of customization and control.

That's where separately managed accounts (SMAs) could help. These accounts also offer professional management, but with a potential level of personalization that is not typically available from mutual funds or ETFs.

Here's how SMAs, mutual funds, and ETFs stack up across five key attributes.

ETFs and mutual funds are essentially baskets of securities that are professionally managed according to a defined investment objective. With passively managed funds, that objective might be tracking the performance of an index, so investors in such funds naturally end up exposed to the same underlying securities. But even with actively managed funds, when fund managers buy and sell stocks in the portfolio, such changes affect all investors in the fund. While efficient, this structure leaves no room to tailor the fund's holdings to any individual investor's specific goals, needs, or preferences.

With an SMA, on the other hand, investors select a strategy that aligns with their goals—similar to how they might select among available fund options—and then they directly own the individual securities in their account. This gives investors room to request adjustments to the holdings in their portfolios based on their personal goals, risk tolerance, tax situation, and values. For example, some investors might want to avoid certain sectors or stocks that don't align with their personal values, while others might want to limit additional exposure to a particular company's stock. To be clear, SMAs aren't 100% customizable—adjustments must be reasonable and align with the manager's strategy, and are ultimately made at the manager's discretion.

To marry the broad diversification of a fund with the customization of an SMA, many managers have begun employing direct indexing strategies, in which an investor owns the individual securities that make up an index and may be able to exclude individual stock and/or industry categories that don't align with their interests or needs. Again, there may be limits to how many changes are permitted.

Tax treatment is one of the most significant differences among these vehicles.

Mutual funds are required to distribute all realized gains to shareholders each year, regardless of when those shares were purchased. This can lead to investors incurring taxes on gains they didn't personally benefit from. Actively managed mutual funds, which have higher portfolio turnover, tend to generate more of these distributions than index mutual funds.

ETFs, too, are required to distribute their capital gains to shareholders, but they have a structural advantage that helps to limit distributions. Thanks to their in-kind creation and redemption process, they're able to swap underlying securities without triggering a taxable event for the investor. As a result, many ETFs can go years without distributing significant capital gains, allowing ETF investors to defer taxes until they sell their shares.

SMAs offer even greater tax control. Because the investor owns the securities outright, a manager can actively harvest losses to potentially offset gains—both within the SMA portfolio or elsewhere, such as gains from real estate or private investments. And because each security has an individual cost basis, the SMA manager can pick and choose which holdings to divest based on the client's capital gains for the year.

Finally, investors can fund their SMA with existing securities, thereby potentially avoiding capital gains. Mutual funds and ETFs, in contrast, require cash to fund purchases, which could force the investor to sell securities held elsewhere and potentially create tax consequences.

ETFs—especially passive, index-tracking funds—tend to be the lowest-cost option. Their primary fee is the expense ratio, which is often below 0.2% for stock ETFs, and they generally have no formal minimum beyond the cost of a single share.

Mutual fund fees can vary widely depending on the fund's approach and strategy, but typically run between 0.25% and 1% of the total invested each year. Some mutual funds also charge commissions (known as a sales load), though many no-load funds exist, especially in the index fund category. And investment minimums for mutual funds typically range from as little as $500 to $5,000, depending on the fund and share class.

SMAs generally are the most expensive option of the three, with fees averaging about 1.34% of assets under management, though pricing is often tiered for larger accounts. For investors needing customization and tax optimization, the added cost may be justified. However, SMAs usually come with high investment minimums—often $100,000 or more—making them more suitable for high-net-worth investors.

ETFs trade throughout the day at market prices, offering intraday liquidity that allows investors to buy and sell at any time during regular trading hours, similar to stocks.

Mutual funds offer once-daily liquidity. Investors can place buy or sell orders at any time during the trading day, and trades are executed at the fund's net asset value (NAV), calculated after market close. While execution is not intraday, the ability to transact daily provides a reliable and predictable liquidity schedule for most investors. It's also worth noting that mutual funds can be purchased as whole or fractional shares, or in fixed dollar amounts. Keep in mind also that some brokerages might charge short-term redemption fees when mutual funds are sold before a specified holding period (e.g., 90 days).

Investments within an SMA can generally be sold during regular trading hours, with the manager selecting which shares to sell to maximize tax efficiency and maintain the portfolio's composition. Depending on your investment mix, settlement can take as little as a day or two days for highly liquid investments to several days or more for niche or illiquid holdings. However, full liquidation of an SMA portfolio is not instantaneous and will largely depend on custodian procedures, platform processing timelines, and any manager-imposed trade restrictions.

There are two aspects of transparency worth considering:

• Holdings: Mutual funds are opaque, offering visibility into their holdings on a monthly or quarterly basis—often with a 30- to 60-day lag. Conversely, most ETFs (some are less frequent) and SMAs offer full daily transparency, down to the individual security level. Where SMAs have ETFs beat is that an SMA investor can generally view every position, trade, and price in real time, knowing exactly what they own at a given moment.
• Fees: The disclosure of management fees is another area where SMAs stand out, as they typically disclose such fees as a separate line item on investors' billing statements. Mutual funds and ETFs, on the other hand, disclose their operating expense ratios but investors may not know exactly what they paid or when as the manager deducts their fees from the fund's assets throughout the year.

In the end, choosing between funds and SMAs isn't about which is better, but rather which is better suited to your goals, preferences, and financial complexities. For those who value the potential for customization and are willing to invest accordingly, SMAs may offer a compelling alternative to traditional funds.