A deep dive into the history and current meaning(s) of SMA and UMA.
SMA stands for Separately Managed Account. And UMA stands for Unified Managed Account. So far, so good. But what do they mean, precisely?
It’s a trick question. There’s not one, but many answers. We know from experience that the terms SMA and UMA mean different things to different people. Which, of course, causes confusion. We think we can help. Last year, we wrote about the multiple meanings of “model” (A Model of Miscommunication and Choose Your Words Carefully). Here we do the same for UMA and SMA.
SMAs are basically unbundled mutual funds. Like mutual funds, SMAs are professionally managed. Unlike mutual funds, investors directly hold individual securities, e.g. IBM, F, etc.
To make sense of how the term SMA is used, a bit of history is useful. SMAs were introduced as a way for individual investors to invest like large institutions, understood as the practice of first deciding on an asset allocation, then hiring different specialists to manage the funds allocated to each asset class.
With true institutional accounts, the third-party managers were typically just sent money. Creating consolidated holdings and performance reports was a manual and expensive process. To serve individual investors, something simpler was needed. APL and others introduced systems that divided a client’s holdings into sub-accounts (also called partitions or sleeves). Each of the third-party specialists would get its own sub-account to manage, free of the interference of other third-party specialists, and the sub-accounting systems simplified the process of generating holdings and performance reports. The results were the first generation of SMAs, which we’ll call “traditional SMA”.
Model-based overlay SMAs
Unfortunately, even with sub-accounting, SMAs were still burdened with high costs and high minimums. There was no standard protocol to communicate with the third-party managers, so much of it was done by phone and email. There was no practical way to coordinate the activity of the different managers to prevent wash sales, or even avoid buying/selling of the same security on the same day in different accounts. Transferring assets between managers (necessary when rebalancing at the asset class level) was time consuming and tax-inefficient.
In response to these limitations of traditional SMAs, the workflow was further simplified. Instead of directly managing assets, the third party specialists simply provide a portfolio model to the primary client advisor, who takes on responsibility for all trading. Call this “models-based SMA.” Not all strategies lend themselves to a models-based approach. It only works if the underlying securities are highly liquid. If efficient trading is a key component of the specialist’s skill set — as with, say, muni-bonds and micro-cap stocks — a models-based approach is not appropriate.
Will the real SMA please stand up?
For some, the term SMA is synonymous with what we’ve called “Traditional SMA.” Others use the term SMA more broadly to mean Traditional SMA or models-based SMA. We don’t have any strong opinions about the “right” usage. To avoid confusion, we usually avoid using the standalone term SMA in favor of the more descriptive “traditional SMA” or “models-based SMA.”
While models-based SMAs were a step forward, they still suffered from major limitations. In particular, SMAs were managed separately from the rest of the client’s portfolio, which might also contain mutual funds, ETFs and in-house equity portfolios (where your advisor buys/sells stocks based on his or her own research). This made it difficult to manage the client’s portfolio as a whole.
UMAs were created to address some of these problems. The term UMA (Unified Managed Account) is meant to describe a single account that contains any combination of SMAs, mutual funds and ETFs, with consolidated holdings and performance reporting. There are two basic ways to accomplish this.
Sub-account (sleeve-based) UMAs
Sleeve-based UMAs are modest extensions of SMAs, in which, basically, you add extra sleeves to hold mutual funds and/or proprietary (in-house) equity holdings. This sounds trivial, but when SMAs were first rolled out, the sub-accounting system was usually separate from the main accounting and trading system used for mutual funds and in-house equities. Creating UMAs required consolidating all these systems.
Blended-model (holistic) UMAs
Sleeve-based UMAs are more efficient than predecessor SMA programs. However, that’s a little bit damning with faint praise. Sleeve-based UMAs, even models-based SMAs, are still expensive and unwieldy. The problem stems from the whole idea of sub-accounts. First, the systems that keep track of the different sub-accounts are expensive to maintain. Second, and more fundamentally, dividing up an account makes it difficult to manage the portfolio as a whole. Certain characteristics of a portfolio, risk especially, are not properties of individual securities. They’re properties of the portfolio as a whole. Managing risk, especially in the presence of customization and tax optimization, requires a holistic approach, which means no sub-accounts.
Like other model-based SMAs, blended-model (holistic) UMAs start with the idea of having third-party specialists hand over models. But they dispense with the whole idea of sub-accounts, treating them as a vestigial remnant of the whole institutional approach from which SMAs sprang. Instead, the various models from third-party specialist are blended together into a single composite (or “blended”) model. The client’s (unpartitioned) account is then managed to this one composite model — holistically.
Note that if an SMA is implemented this way (with blended models), it’s automatically a UMA. There are no extra steps needed to include mutual funds and proprietary models, and no extra sleeve that needs to be created. Instead, the mutual funds, ETFs, proprietary models, etc. are just added to the composite model in proportion to their desired weight in the portfolio.
The sub-account UMA and the blended-model UMA are very different. We’ve written about this difference on multiple occasions under a slightly different set of labels: “sleeves vs. no-sleeves.” You can read what we’ve written on sleeves here:
- Ultimate Guide to Sleeves Part I
- Ultimate Guide to Sleeves Part II
- Don’t Treat Investors Like Institutions
- A Guide to Choosing a Rebalancing System
Will the real UMA please stand up?
As with the term SMA, we don’t think there’s a single correct definition of UMA. To avoid confusion, we just refer directly to the two different types: “sleeve-based” (or “sub-account-based”) UMA and “blended model” (or “holistic”) UMA.
We’ve presented the evolution of SMAs to UMAs, from “traditional SMA” to “blended model UMA,” as a straight progression. The actual history is a bit more convoluted — some of these systems evolved in parallel, not in succession. And not everyone shares our view that blended model UMA is the best approach (we’re a blended-model UMA systems provider, so we can’t claim to be neutral). What everyone can agree on, though, is that the terminology can be confusing. Regardless of the type of system you want, we hope this guide will help.