SMAs are becoming the latest fund format to appear on ETF menus

The bubble exchange-traded fund industry is threatening to take something away from separately managed accounts, having already eaten the mutual fund sector’s lunch.

Since the start of 2021, mutual funds have seen more than $1 billion in outflows in the U.S., even as bright upstart ETFs pulled in $2 billion, according to Morningstar figures. ETFs also gained market share in Europe and Asia, albeit at a slower pace. This has led to a flurry of conversions from mutual funds to ETFs as asset managers have turned to the ascending fund structure.

Now, some in the ETF industry are turning their attention to SMA, another fast-growing segment of the $120 billion global asset management industry.

HANetf, the London-based white label ETF issuer, recently completed what it believes is the first SMA to ETF conversion in Europe. This builds on a developing trend in the US, where Tidal Financial Group and Goldman Sachs have also made similar conversions on their ETF platforms.

“It’s been happening for a few years now (in the US). It really caught everyone’s attention earlier this year when Eagle Capital Management had a conversion of over $1 billion (via Goldman),” said Jeff Tjornehoj, senior director of fund information at Broadridge, a fintech consultancy.

“That something so big could happen (people surprised).” The prevailing view was that “SMAs were doing quite well and didn’t need disruption,” Tjornehoj added.

“I think we’re at the beginning of this trend,” added Eric Hewitt, chief investment officer at SS&C ALPS Advisors, a boutique investment manager, who said many of his registered investment adviser clients still weren’t even aware of SMA conversions to ETFs. were possible.

SMAs are professionally managed customized diversified vehicles that offer a personalized investment approach tailored to an investor’s goals and preferences. They are popular with wealthy investors, catering to individuals or groups of people such as families.

They have grown rapidly in recent years, with assets in the U.S. alone rising from $952 billion in 2017 to $2.2 billion at the end of last year, according to Cerulli.

Despite this growth, some SMA managers and investors now appear to be looking at the ETF option.

HANetf’s initial conversion was of an SMA managed by Lloyd Capital, a Swiss wealth manager, on behalf of a Mexican family office. It spawned two ETFs: Lloyd Focused Equity Ucits ETF (FEP) and Lloyd Growth Equity Ucits ETF (GEP).

Hector McNeil, co-chief executive of HANetf, said Lloyd Capital “had a number of reasons for doing this”.

One was tax-related, for example Irish-domiciled UCITS ETFs paying a reduced 15% withholding tax on US dividend income, something “you wouldn’t get with a segregated mandate”.

The second was that the ETF conversion allowed Lloyd’s to create “a centralized offering”, opening the door to smaller clients and attracting outside money that would not have access to an SMA, helping to achieve economies of scale.

According to McNeil, the two ETFs, with combined assets of $324 million, have attracted $5 million in third-party money since launching in May.

McNeil said HANetf is now in talks with a large UK wealth manager looking to unify its existing SMA-based investment proposition because “they have so many managers going off the rails”, which may invite to the control of unwanted regulations.

In the US, tax has been the main driver: as with mutual funds, US SMAs must pay capital gains tax on winning positions each year, while the unique trading structure of ETFs often allows them to to avoid these obligations, investors in many cases pay tax only when they sell their holdings.

“SMA can be quite tax inefficient, while the US ETF can be ridiculously tax efficient. Most investors welcome this,” added Mike Venuto, co-founder and chief investment officer of Tidal Financial Group, the world’s largest white-label producer with about 130 ETFs, including the Days Global Advisors Absolute ETF Return (HF) of $18 million, which converted from an SMA earlier this year.

Hewitt said he’s heard from RIAs running SMAs that many investors are “locked in” in that they’re relying on high capital gains and “at some point, decision-making shifts away from optimal (investment) exposure to managing tax exposure”. scenario that ETF conversion can help alleviate.

Tidal says it is currently in discussions with about 50 RIAs about either converting SMAs to ETFs or launching ETFs that duplicate the strategies of their existing SMAs.

However, an unusual SMA sports customization might have trouble finding a wider audience as an ETF, so one option was simply to have only non-custom parts undergo the conversion, Venuto said.

There are, however, potential downsides. Converting to an ETF would force SMAs to comply with diversification rules, Tjornehoj said, while ETFs cannot hold private placements or other illiquid products.

“There is also some success as an SMA customer,” he added, with some wealthy investors likely looking down on a product anyone can buy.

Tjornehoj thought the pace of conversions would be slow, “maybe five (this year in the US) and maybe two times in 2025.”

SS&C also, despite “many inquiries from our clients”, did not expect the emerging trend to “affect the growth of SMAs”.

McNeil foresaw further conversions in Europe, however.

“It’s definitely something that resonates with people (in the U.S.) and what happens in the U.S. in the ETF space usually comes to Europe,” he said.