In recent years, the concept of a separately managed account (SMA) has evolved from a niche allocation vehicle to a method of preference for deploying capital by institutional investors to both established and emerging managers. Their popular appeal lies in their ability to offer customization, transparency and control over investments. AIMA’s recent webinar gathered industry leaders from Ontario Teachers’ Pension Plan (OTPP), Caisse de dépôt et placement du Québec (CDPQ), MassPrim and Innocap to explore the mechanics and growing appeal of SMAs. Here’s are the key takeaways.

What is a separately managed account?

A separately managed account (also known as a managed account or dedicated managed account) is an independent fund structure established for a single investor. It can be considered a “fund of one” that the allocator owns and controls while delegating trading authority to an investment manager.

What does an SMA do?

The key difference from traditional commingled hedge funds is that the investor retains ownership and oversight of the underlying assets, enabling the allocator to shape every aspect of the investment – from operational due diligence and choice of administrator, prime broker, and auditor, right down to setting investment guidelines and risk limits.

How does an SMA work?

The typical SMA setup involves a platform manager that is responsible for fund structuring, fund governance, manager onboarding, cash settlements, trade collateral movements, treasury optimization and more. The platform manager would also oversee guideline monitoring and fund oversight including fees, with the fiduciary duty remaining with the platform manager.

While the platform manager oversees and operates an SMA, it requires service providers to service the fund, which would include a fund administrator, trading counterparties, auditors and others such as banks.

An asset owner would then allocate to the SMA while the asset manager would trade based on the investment guidelines provided by the allocator’s mandate.

Why are SMAs becoming more popular now?

According to the panelists, JP Morgan expects 58% of new launches over the next 12 months will be done in SMAs, while Goldman Sachs envisages the SMA space to grow by $400bn+ by 2027. Furthermore, panelists noted new Morgan Stanley Prime Brokerage Accounts in SMAs have frown from 9% in 2023 to 74% in Q2 2024. Popular too with many of Canada’s Maple 8 Pensions, the move toward SMAs is a structural shift driven by LPs determined to extract the greatest value out of their hedge fund allocations while maintaining transparency and alignment of interests. Several SMA features are driving this shift:

Transparency

Asset owners crave real-time visibility into their portfolios. SMAs offer daily or near-daily position-level transparency and the ability to monitor trade activity and counterparty risk exposures in real-time. After more than a decade of pressing for better insight into manager portfolios, allocators can now access heightened visibility and significantly improve both investment and operational risk management. For example, if a global event were to suddenly unfold, such as during the 2020 Ukraine-Russia crisis, allocators can instantly quantify exposures and act decisively. This control feature of SMAs is proving invaluable in today’s geopolitically-tense world.

Customization

Want ESG exclusions? Got it. Specific risk limits? No problem. Prefer not to invest in certain regions or industries? Easy. SMAs allow allocators to dictate terms that align with their unique investment mandates, whether that’s adhering to state regulations or targeting niche opportunities. This customization feature reduces complexity across the institution and complements holistic investment management strategies. Contracts, legal templates, reporting formats, and compliance checks can be standardized and repeated across multiple SMA relationships. This results in more streamlined operations and better integration with the broader portfolio mandate.

Capital efficiency

Perhaps the least discussed, but potentially most impactful, advantage of SMAs is the improved utilization of capital. Traditional fund structures often require full funding of the committed capital upfront, which can lead to idle cash and sub-optimal returns. By contrast, SMAs can employ notional funding and cross-margining techniques to reduce the amount of idle collateral. When combined with today’s higher interest rates, the savings can be meaningful. Allocators have been able to generate significant “structural alpha” via SMAs; in other words, they saved millions by optimizing cash usage and financing costs through enhanced margin efficiency and improved financing conditions. In an environment where every basis point counts, even a 1–2% improvement in return achieved purely through better capital optimization is too large to ignore.

Control

SMAs shift key operational controls away from the investment manager and into the allocator’s sphere. The platform manager coordinates the entire ecosystem, including fund structuring, governance, accounting, cash management, and operational oversight. This arrangement frees the investment manager to focus solely on generating returns while the allocator and platform manager ensure that operational, legal and compliance arrangements meet institutional standards.

The new SMA landscape

Many managers appreciate that SMAs offer an opportunity to deepen relationships with large, long-term allocators. They also recognize that SMAs often mean more stable capital, better alignment, and reduced distractions from non-investment administrative burdens. As a result, leading managers now routinely entertain SMA proposals, while emerging managers or those offering very specialized strategies see SMAs as a real game-changer to grow their investor base. Investors can back a promising emerging manager with more transparency and operational controls, de-risking part of this endeavor. With the SMA platform in place, operational complexity and risk are substantially mitigated, allowing for the expansion and promotion of emerging talent with institutional guardrails in place, paving a pathway for up-and-coming managers to institutional capital.

SMAs are here to stay

Ultimately, the SMA model delivers a degree of flexibility and alignment that traditional structures may struggle to match, shifting the LP-GP dynamic into an active partnership. Investors can customize investment terms, access manager intel and insights while retaining full control, with managers then able to focus on their core competency: investing well and generating alpha.

SMAs have made their way into the institutional investing toolkit, with transparency, customization, control and capital efficiency becoming non-negotiable. As leading institutional allocators continue to embrace these tools, the rest of the industry is increasingly following suit.