Over the years, we can’t count the number of times we have had to explain the difference between a separately managed account (SMA) and a fund structure. Until this day, many investors may still not completely understand the differences between the two. Given much of the confusion and misunderstanding, we felt that it would be helpful to put together a small piece that outlines the pluses and minuses of the two different types of investments. Both options have been accessible to investors for quite some time, however knowing the benefits of each will help you determine which is best suited for you as the investor. Please refer to the chart below, which outlines the benefits/disadvantages of SMAs and funds.
For years, investors have used the benefits of a separately managed account. The most sought out reason to invest via SMA is transparency and liquidity. Through a SMA structure, investors have the ability to monitor their accounts on a daily basis, along with having the ability to liquidate their investment with a 24 hour notice. Many investors love that SMAs are liquid, essentially having access to their cash within a few days.
The next two benefits of investing through SMAs, notional funds and cross margining , are related to one another. Many CTA managers utilize a small portion of their minimum investment to conduct trading activity to generate returns. With this, investors have the ability to use notional funds to invest with many of these managers. For a discussion on what notional funds are and how they can be utilized, please read our past article What is Notional Funding?. With the use of notional funds and cross margining, investors have the ability to participate in CTA managers with capital lower than the stated minimum investment (notional funding involves greater risk and carries potential for greater losses on a percentage basis). Finally, given all the ponzi schemes over the last two decades, many investor shy away from investing in funds. They prefer the capital stay in their own name, instead of handing their money over to a fund. In a SMA structure, your capital sits in your name at the FCM (Futures Clearing Merchant) of your choice, which acts as a third party to clear all trades and handle all client capital. The brokerage firm, advisor, or CTA you are dealing with will not have access to any of your capital.
Although SMAs may have many benefits, they do have some disadvantages, as well. Probably the biggest disadvantage would be higher minimum investments. Through a Fund structure, managers have the ability to trade in small unit sizes giving investors the ability to invest with less capital, however through SMAs this is not possible. Furthermore, notional funds act both as a benefit and a disadvantage for investors depending on how they are utilized. Using notional funds means you are using greater leverage in your investment. Leverage can either be your friend or your foe, depending on many different circumstances. In times of positive performance, notional funds/leverage is the best thing on earth but in times of negative performance you wish you never invested. Lastly, having many SMAs it can become increasingly difficult to monitor/track all the performance of your CTA investments. However, as a client of aiSource, this is actually not a disadvantage given our aiTracker tool.
Similar to SMAs, Funds have its advantages and disadvantages. Funds have three distinct advantages over SMAs; smaller investment minimums, access to larger CTA managers, and more recently the addition of fund administrators to Fund investments. One of the drawbacks in investing through a SMA is that many of the well known CTA managers have high minimum investments, which makes them out of reach for the everyday investor. For that exact reason, these larger CTA managers offer Fund offerings, which gives investors access to the strategy with smaller investments. The last added benefit of a Fund is fund administrators. Although this is not a direct advantage, it more recently has become the norm for Funds to hire fund administrators. Fund administrators help with fund reporting, along with acting as a third party which handles the investor’s capital. Fund administrators are employed to prevent ponzi schemes and the mishandling of investor capital. If you are looking to make a fund type investment, it is highly recommended to ensure that the fund has a qualified and reputable fund administrator that oversees the handling of all cash transactions.
Fund investments, do however, have a few disadvantages. The biggest disadvantage is transparency and liquidity. Unlike SMAs, most Funds do not offer daily transparency, but instead offer statements on a monthly or quarterly basis. This removes the ability for an investor to monitor their investment on a daily basis. Also, many Funds have lock up periods which restrict investors from withdrawing their investment for a specific period of time. Lock-up periods can range from 1 month to a year or even greater depending on the investment. The last disadvantage for Fund investments is capital inefficiency. Unlike SMAs, Fund investments are less flexible (for the investor) and do not allow the use of notional funds/cross margining. Without the use of notional funds/cross margining investors are forced to place all capital with one CTA manager, instead of spreading out their investment across multiple managers like in a SMA structure.
Since every investor has specific and unique investment goals, the team at aiSource prefers to utilize the SMA investment structure. Besides having greater transparency and liquidity, SMAs are more flexible for investors and easy to make on-going changes to an overall CTA investment portfolio. For over 15 years, aiSource and its parent company, Lakefront Futures & Options, has worked closely with investors to help provide a CTA investment solution that appeals to their risk/reward appetite. Further, aiSource continues to help monitor the portfolio on an on-going basis making any necessary changes along the way. Contact aiSource today for a portfolio consultation.