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Robo SMAs will Replace Mutual Funds

Robo technology is not a threat to advisors. It's a threat to mutual funds.

Robo SMAs

Robos — more precisely, robo technology — pose a threat to a key player in the industry, but it’s not advisors.1 It’s mutual fund companies. The threat comes in the form of what we’ll call “robo SMAs” — customizable, tax-optimized separately managed accounts managed at low cost using automated account setup and rebalancing technology.

We’ve previously posted on why SMA’s are better than mutual funds for most assets (A Guide to Mutual Funds vs. SMAs). We’ve also posted on the special case of direct index SMAs and why they’re better and potentially cheaper than ETFs (Direct Indexes are Better than ETFs and Direct Indexes: Cheaper than ETFs?). You can read more in these previous posts, but the basic idea is that SMAs are more tax efficient, and unlike mutual funds, they’re customizable. With SMAs it’s also easier and faster to launch new products — no new registrations or legal documents are needed — you just have to create a new model portfolio. And under the right conditions, SMAs are also less expensive to operate. What are the right conditions? You need two things:

  • Fractional shares and AUM-based trading costs (e.g. no $4.95/share commissions): When you’re buying a basket of 100 stocks for each client, even $4.95/share adds up. And having to both buy whole shares and own the stocks in the right proportions means you need high account minimums, putting SMAs out of reach for many investors.
  • Automated tax-optimized rebalancing of customized accounts: One of the main advantages of SMAs over mutual funds is that they’re customizable and more tax efficient. If SMAs are to replace mutual funds, these services need to be delivered at scale.
The scary thing for mutual fund companies is that these technologies already exist:
  • Custodians like Apex and FolioFn support fractional shares and AUM-based trading costs, meaning investors with as little as $100 can invest in SMAs.
  • Technology like, well, ours supports automated tax-optimized rebalancing of customized accounts, at least for highly liquid securities like US large- and mid-cap equities.

This should worry mutual fund companies. What’s their response? It’s to move into the SMA business. And they won’t stop there. In addition to individual SMAs (the direct equivalents of mutual funds), they can expand their service to include asset allocation, customization and tax management. To top it off, once this infrastructure is in place, they’ll be in a position to roll out new strategies literally overnight — even offer custom “dial-a-smartbeta” customized models (see Asset Managers Pivot to Sell Solutions, Not Just Product).

To make all this happen, the mutual fund companies will have to do one more thing: make account setup and onboarding easy. Really easy. Being an outsourced overlay manager is a subadvisory service that requires the signoff of the investor and the custodian. But robo advisors have demonstrated the viability of automated, real-time setup of advisory accounts.


It’s all pretty disruptive, but that’s a good thing. The biggest winners in all this will be investors. They’ll pay less and get more. And the mutual fund companies that adapt will do OK, too. Goodbye, mutual funds. Hello, robo SMAs.


If you're interested in reading more content like this, here's an index to our most popular posts.

1 We’re sometimes asked if we think robo advisors will replace human advisors. We think the answer is no — robos will no more replace advisors than Turbotax replaced accountants. That being said, the role of the advisor will change. Advisors will increasingly focus on financial planning and other “life coach" activities, and they will not be compensated for doing things that robos can do just as well or better (like rebalancing). But they will not be going away.

President, Co-Founder