Separately Managed Accounts
Rohan Rekhi
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What is a Separately Managed Account?
A separately managed account, or SMA, is just what it sounds like: a portfolio of securities that’s professionally managed separately from other portfolios. The portfolios are made up of stocks, bonds, and other securities and can be customized to align with an investor's unique goals and preferences. SMAs are managed by investment professionals and designed for high-net-worth (HNW) individuals who have specialized or sophisticated needs and seek bespoke investment solutions.
Managed Account Platforms
Wealth management organizations and advisors are positioned to deliver better investor outcomes by simplifying the construction and management of highly tailored portfolios. They support some of?the largest and most respected firms in the industry.
These platforms are managed account technology platforms that lets you build out a diversified asset allocation with securities, active or index-based SMA strategies, mutual funds, ETFs, and cash... all in flexible sleeves... each with different trading discretion... while preserving true sleeve- and tax lot-level portfolio accounting... all possibly in a single custodial account. The platforms enable tax management and personalization across the entire portfolio – at scale – for even the smallest of accounts.
Today I want to talk about some of the key concepts for Separately Managed Accounts.
Models & Products
Models, investment products, investment objectives, and strategies define the target holdings and determine what securities are proposed and held in SMA accounts.
·??????? Models?define the securities for a managed account, including the weights. Models can be used with multiple Account Types.
·??????? Investment products?are used with?investment objectives?to define account holdings for all account types. The objective sets the target weights for general asset classes and/or categories (e.g., 50% equity, 35% fixed income, 15% cash). The product specifies the specific investment vehicles that accounts within each allocation segment are permitted to hold, in order to achieve the objective.
·??????? A?strategy?controls the allocations for sleeves within an
Models:
Models define the target holdings and rules that are used to manage an account. Models define the constituent securities, weights (percentages of holdings), and trading rules and restrictions that you apply to managed accounts, including tax harvest securities at the model and position levels.
Model Types:
Standard Model: A standard model is used for equities, mutual fund, or fixed-income models (but it cannot contain short positions). A tax-harvest security can optionally be assigned at the position level in standard models.
A standard model can be either quantity-based or weight-based:
Security-only Model: Security-only models?function essentially the same way as standard models, except that they don’t include an option for adding a cash position. In other words, stocks, mutual funds, and ETFs are allowed—everything except cash.?A tax-harvest security can optionally be assigned at the position level in security-only models.
Template-based Model: A template-based model is generally used when you plan to trade characteristic-based fixed-income securities, or for a mix of fixed-income securities with mutual funds. It may also be used for equity modeling, though this can be less commonly done. A template model cannot contain short positions.
A template-based model can be either weight-based or quantity-based:
Linked-Account Model: A model may also be a "linked-account model," which is a quantity-based model (the target holdings of each security are specified as a number of shares) in which the quantities are defined by the holdings of a particular account. In other words, the holdings in the account represent the target quantities of the model.
Flexible Model: A flexible model is used to designate that an account or sleeve does not have a target position. Instead, the user has flexibility to define what securities should be held in the account. Thus, flexible models contain neither securities nor template positions, but merely model options (i.e., trading settings, such as minimum trade size constraints). An account that follows a flexible model cannot undergo a tactical trade generation process, since there are no target model positions to which to aspire. However, users can perform adhoc and trade to target trade generation sessions as desired. Flexible models are often used by reps acting as managers. Selecting this type of model indicates that the rep will trade the account or sleeve linked to this model directly (as there are no securities held in the model, there are none to be used as a guide). While a flexible model cannot contain short positions, accounts and sleeves following a flexible models can contain short positions.
Asset Allocation Model or Policy: An asset allocation model is used to designate a set of security group targets (e.g., asset class, sector, industry). This allows a user to monitor drift from the selected security group targets, instead of from a set of specific securities or template positions. An asset allocation model is generally used for households and account groups. It allows the specification of target weights to security groups within a household or account group. It is sometimes useful to assign an account to an asset allocation model; for example, mutual fund wrap accounts could be assigned to asset allocation models. This would allow you to monitor when the asset allocation of the mutual fund wrap account moves outside the tolerance specified in the asset allocation model.
Index Models: Model types are available that support the integration with proposals that feature direct indexing. Proposal information goes between to the optimizer via APIs, and the optimizer generates trade scenarios according to the proposal’s guidelines.
Quantity-Based vs. Weight-Based Models
Both standard and template models may be set up as quantity-based or as weight-based.
The key difference between quantity-based and weight-based models is how market price changes affect drift.
Sample account holdings with the start-of-day market prices. Note that the account is exactly aligned with the model at the start of the day:
As market data changes, the weights in the model change:
Note that the account is?not?drifting due to market data changes:
Weight-Based Model:?Example
A simple weight-based model:
Account holdings with the start of day market prices. Note that the account is exactly aligned with the model:
As market data changes, the model weights do?not?change.
Since the model weights do not change with the market price changes, the account drift is affected by the changed market prices. Each account position shows as drifting based on the market price changes:?
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To generate a quantity-based model, start with a weight-based model and assign an arbitrary value for the model. You can then calculate the number of shares to create a fixed quantity-based model whose weights vary as market prices change.
Template-Based vs. Standard Models
Where a standard model defines a list of securities with targets, by contrast, a template-based model defines a list of either specific securities or generic (i.e., characteristic-based) securities with targets.
A template-based model is particularly useful when modeling securities with low-liquidity, such some fixed income security types. A template-based model lets you define a list of targets based on security characteristics instead of specific securities
The trading session creates proposed trades differently for security versus template-model accounts. The trade generation behavior is determined by several options, which determine whether one can optimize proposed trades for long-term and short-term gains management, detect and manage wash sales conditions, monitor investor restrictions, and manage account turnover.
All accounts are monitored for drift away from their respective models, including violations of security limits established for the account.
When holdings exceed the specified model options, proposes the trades required to bring the account back into conformity with the model.
You can customize either model type by specifying restrictions, trading behavior, cash treatment, and tax treatment.
However, restrictions are not applied to generic securities in template-based models.
Dynamic Weight based Model: A dynamic weight-based model fluctuates alongside market prices. Starting portfolio value for dynamic models is used when importing target weights into a quantity-based model, as the new model position quantities are calculated using the latest market price for each security and the amount specified here.
Minimum Percent Change: This parameter is a relative percent, so that the threshold value will be based on the previous target weight. For example, a 1% Delta threshold causes a delta of 0.03% on a position target of 2% to be highlighted, while a delta of 0.03% is not highlighted on a position target of 4%. The default value of Delta threshold is 1%.
Cash Target: There are typically 3 options for determining the cash target: 1) Use the model’s cash target, 2) Use the model’s cash target so long as it is above a minimum value, and 3) Apply a cash buffer on top of the model’s cash target.
Cash Tolerance. You can enable an absolute percentage band above or below the cash target, an absolute percentage cash ceiling or cash floor, or a relative cash tolerance that fluctuates alongside the model's cash target.
Enable a relative cash tolerance: The specified relative percentage value is used to calculate a cash floor and cash ceiling, which varies depending on the sleeve model’s cash target. (The default/disabled value is -1.)
Rebalancing Tolerances: Specify the tolerances to be used during trade generation when rebalancing the accounts that follow this model.
Account Alerts: Specify whether you want to enable tactical impact alerts, position drift alerts, or both, for the accounts following this model.
Tactical Impact: controls a sleeves or account’s Tactical Impact indicators and alerts
Position Drift: controls a sleeve’s or account’s Position Drift indicators and alerts.
Maximum Security Weight: Use this to enable a maximum weight for any single security in the model. Then, specify that maximum weight as a percentage.
Primary Restriction Reinvestment Rule: A model’s primary restriction reinvestment rule is applied automatically by the rebalancer when it is proposing reinvestment. The rule is always applied, even when there are no restrictions in place for the model or the account.
Secondary Restriction Reinvestment Rule:
Prorate across model: Pro-rate any reinvestment money across the model, beginning with the top-rated security in the model buy list.
Prorate across security group: Security Group options can be Industry Classifications and Security Type hierarchies.
Leave in cash: Leave any reinvestment money in cash. Note that the weight of cash from the restriction reinvestment will not be used for trading or to satisfy the account/sleeve cash floor.
Minimum Size: Enable a minimum trade size for buys of new positions. The trade amount values are either calculated based on portfolio value, OR you can set a minimum trade amount (a floor).
Tax Harvest Security: Specifies an optional security to be used to invest the proceeds from a tax harvest for a loss, in a replacement security.
I will continue these thoughts in my next Article around Model Workflows and Model Deliveries.
#seperatelymanagedaccount #modelworkflow #modeldelivery
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