Advisers are increasingly using SMAs that replicate managed fund model portfolios, but they could be exposing clients to large tracking errors, warns Ralton Asset Management.
SMAs, or separately managed accounts, are an alternative to unit trusts and allow clients to have full transparency of their portfolio while entrusting management to an external party.
The majority of SMAs replicate an existing unit trust in a 'model portfolio' structure.
However, Ralton Asset Management chief investment officer Andrew Stanley, whose firm runs what he calls a "pure" SMA that is not based on existing unit trust, said the model portfolio structure comes with risks for investors.
"SMA portfolios need to have fewer and less volatile stocks, they should have less trading in and out of positions and need to be rebalanced differently," he said.
"If not managed carefully, large tracking errors can open up between SMAs and their underlying managed fund portfolio and investors, particularly those with smaller SMA portfolios, can be disadvantaged by high costs that are highlighted by very long and confusing trading reports."
While he said he was "delighted" that SMAs are gaining traction (he has been running Ralton's SMA since 2008), he is concerned about the practice of "dressing up" a managed fund to look like an SMA.
"We're afraid that will create a really bad user experience and ultimately turn investors and advisers off SMAs," Mr Stanley said.
"Because SMA investors own their portfolio directly in their own name (not a unitised product) they receive trading reports detailing every change made to a portfolio.
"Tracking error is the difference between the model portfolio performance and the underlying managed fund the SMAs track. Two areas can open up tracking error: different stock positions and the timing of execution of trades on the fund versus when they are executed on the SMA.
"Some managed fund operators of SMAs replicate managed fund trades to reduce tracking error, but then create high levels of turnover. A managed fund can be passively reweighted through inflows and outflows, while SMAs require active reweighting to achieve the same portfolio construction.
"Every change to any stock within the portfolio results in passive changes to the remainder of the portfolio."
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