The Value of a Separately Managed Account

By Barb Shegog

Although some may have viewed SMAs as a short-lived phenomenon, they offer benefits like additional yield, better diversification, more transparency and greater control. 

The Securities and Exchange Commission recently voted unanimously to propose rules that would reform the way that money market funds operate in order to make them less susceptible to runs that could harm investors. This has prompted a continued search for alternative investments. Particular interest has been on separate accounts.

Although some may have viewed separately managed accounts (SMA) as a short-lived phenomenon, many have been taking advantage of what they have to offer: a good balance of risk and reward as well as capital preservation.

More risk for the same yield

Since the crisis, money fund investors have accepted extremely low yields and high fees from money funds for the principal protection and constant net asset value that they offer. The current book value treatment afforded to money funds also allows the fund to be marked at cost and accrue income. As a result of this book value treatment, an MMF offers no volatility and almost no yield. But after the proposed regulations take effect, which some think is likely, money market funds will offer some volatility and almost no yield. The notion of more risk for the same yield contradicts basic financial theory.

Given the investment options outlined in Figure 1, the obvious choice is simply to switch from a prime fund to a government-only MMFs, which are keeping a constant NAV. This might not be the best solution, said Jerome Schneider, managing director at PIMCO. That’s because investors with more than $500bn in assets could be considering the same move. That means shrinking supply and higher demand. “Both retail and institutional investors could be left out in the cold if the supply-demand dynamic leads sponsors of government focused money market funds to spurn additional inflows due to more limited investment options,” Mr. Schneider said.

This leaves an SMA as the most viable option. Separate account management may feel like a fad or a quick solution to a new problem. It is not. Mr. Schneider explains that several money managers have successfully managed alternative funds outside the MMF realm for decades.

If an investor is able to bifurcate a portion of the assets that are not earmarked for day-to-day operations or are comfortable exposing the liquidity pool to some volatility, now is the time to consider a separate account for your liquidity needs. A separately managed account can offer additional yield, better diversification, more transparency, and greater control over the investable investment universe.

SMA’s: Better diversification

Separate account strategies can look to invest in a wider set of asset classes beyond money-fund eligibility criteria (such as Rule 2a-7 limitations on credit quality and maturity.) The broader universe offers investors more diversification and reduces concentration risks.

One of the greatest benefits of moving to a separate account is greater control over the investment in the account. You can determine an investment policy that works best for the given situation. If you do not have in-house expertise, many investment managers are available to partner with who understand the unique needs and challenges of liquidity management.

An active manager will also have more tools in their toolkit to guide the account through a rising rate environment; MMFs have limited options under increasingly tighter regulations. Another benefit is you can choose the risk metrics to measure the account. A MMF fund must provide the same metrics to all investors; there is no customization available. You will receive what the investment managers want you to see.

With any investment decision, the pros must be evaluated against the cons. Money market funds do offer convenience and less oversight by the investor. Although given the push for more transparency, investors have no excuses when it comes to diligently monitoring the funds. A separate account would require selecting a manager, designing an investment policy, and then monitoring the investment portfolio and compliance with the guidelines. With a money market fund, the tighter regulations would give you some comfort in the investments.

Given the uncertain outcome of these proposals, most investors will wait and react once the SEC’s actions are fully implemented. Kevin Kuhner, Portfolio Manager at PIMCO has been urging investors to recognize this possible change in traditional cash management vehicles and educate themselves on alternative liquidity management strategies. But with other destinations cropping up not everyone is waiting around to see what happens.

In light of today’s low yields and tighter regulations, considering a move outside of money market funds to a separately managed account has never been more attractive.