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Direct Investing Brings Customization, Tax Benefits to More Individual Investors

Direct investing through SMAs truly customizes portfolios and manages risk to investors’ specific situations.

Direct investing through customized, separately managed accounts is leading to a new wave of democratization in equity investing. Previously reserved for ultra-high net worth investors, technological innovation has made direct investing in SMAs more widely available.

It has gained popularity in the last five years as minimums dropped, and the ability of managers to customize has increased. For clients with the right investment profile, there are many benefits.

There has been tremendous wealth creation in the last decade. With that wealth has come more and better opportunities for individuals to invest across strategies. For buy-and-hold investors without sources of capital gains elsewhere in their portfolios, ETFs are a low-fee, liquid, tax-efficient vehicle.

For clients with capital gains in other parts of their portfolios, however, whether liquid alternatives or private equity—or single stocks they have been selling over time for diversification—direct investing in their own SMA can provide greater autonomy, control and tax advantages than other vehicles.

Many clients want to align their portfolios with their investment goals or values. Some want to own the market but do not want to own specific stocks or industries. If they work in financial services, for example, they may not want more exposure to large banks if not the entire sector. All this can be accomplished through customized, separately managed accounts.

Originally, direct investing through SMAs was used only by UHNW clients because of the complex operational issues involved in buying individual stocks. It was treated like an institutional mandate with very high minimums, usually $10 million. Over time, those minimums were reduced to $3 million, then $1 million, then $250,000. Some providers now have minimums as low as $5,000.

Investments in technology have allowed many providers to grow and scale while still achieving solutions that address their clients’ needs. These technological advances allow providers to harness the data needed to run these strategies at scale, delivering comparable investment opportunity sets and a consistent client experience, regardless of the account size.

It may be down of late, but the market has had a terrific run over the last 10 to 12 years, and many clients may be sitting on highly appreciated, concentrated stock positions in brokerage accounts.

Clients—and their advisors—may feel the need to diversify these positions. Sector allocations that worked pre-COVID-19, or as pandemic winners, may not work as well in the new economy and current equity environment.

Selling stocks also creates tax liabilities, so advisors often seek to diversify potential tax issues over time by selling positions within a client’s separate account while otherwise maintaining overall investment diversification. Losses in SMAs can be harvested to offset capital gains from individual stocks, potential benefits that have further increased the popularity of direct investing.

Financial advisors have always been excellent sources of ideas to alter the investment universe. An example is the rise of a new capability we call “dynamic diversification,” which came about from discussions with financial advisors in the field. Many asked how to fund these strategies with concentrated positions in highly appreciated tech stocks, such as Amazon, Apple and Microsoft.

In building a process that scales, we are bringing advisors new abilities to run analytics around concentrated stocks and create diversification plans best positioned for each individual. When clients think about aligning portfolios with their values, historical returns can be run in real time, efficiently showing the impact of their goals and helping them make better informed decisions.

This is where the industry is headed: providers making their tools available to advisors, who will then control the customization of dashboards based on what resonates most with their clients.

Investing directly through SMAs is also attractive because it offers liquidity on demand like a mutual fund or ETF. If clients and their advisors decide market conditions are unfavorable, they can terminate their accounts, and the assets will be liquidated quickly and efficiently.

We generally do not recommend this approach as it is incredibly difficult to time markets, but with this strategy clients have that option. If one sector starts to feel too volatile, a client can move assets to other sectors. There are no lock up periods.

Direct investing through SMAs can help investors manage risk over time as it is truly customized to their specific situations. If we can help advisors help their investor clients, the industry will continue to grow. Our goal is that every client we serve finds the right fit.

Monali Vora, CFA, is Head of Quantitative Equity Solutions, Goldman Sachs Asset Management

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