Innovation in Investment Vehicles

January 22, 1993 was a transformative date for many retail and institutional investors. On this date, SPY, the first Exchange Traded Fund (ETF), started trading, ushering in a new era for investment vehicles. Despite investors’ initial uncertainty at the innovative structure of ETFs, they provided investors with new perspectives on the markets, enabling them to access additional market exposure. Today, they are a popular choice for investors.

Investment vehicles like ETFs reorient how investment ideas are expressed. In the 30^th year since the introduction of ETFs, we thought it would be helpful to discuss two that have shaped the investing world– Index Mutual Funds and Exchange Traded Funds (ETFs) despite initial hesitation to adopt them. Then, we’ll explain how we believe Separately ManagedAccounts (SMAs), are positioned to follow in their footsteps as a staple in investment portfolios.

Index Mutual Funds

While the first mutual fund, the Massachusetts Investors Trust (MITTX) will celebrate its centennial birthday next year, it was Jack Bogle, the late founder of Vanguard, who revolutionized investing in 1976 with the introduction of index mutual funds. The premise was simple: buying and holding the broad stock market would provide better results than trying to beat it by picking stocks.

Index mutual funds seek to track the performance of a particular stock market index, such as the S&P 500. The fund manager buys and holds the same securities as the index in the same proportions. As a result, index funds typically have lower expenses and turnover than actively managed funds because they require less trading and research.

In 1976, much of the investing establishment dismissed index mutual funds as a recipe for average results, labeling them “Bogle’s Folly.” However, in the almost five decades since they were introduced, index mutual funds have become a hallmark of corporate 401(k) plans, retirement accounts, and client portfolios. In addition, the focus on low-cost, index-like returns, and broad diversification is a tidal wave that continues to gain momentum within the investment community with no signs of slowing.

Exchange Traded Funds

As we mentioned before, ETFs were introduced in 1993. They are similar to index mutual funds because they track the performance of a particular stock market index. However, they are traded on an exchange like individual stocks, allowing investors to buy and sell them throughout the trading day at market-determined prices. ETFs can also be actively managed, meaning that the fund manager can buy and sell securities in an effort to outperform the index.

Despite investors’ initial hesitancy and uncertainty at the new and innovative structure of ETFs, they became more popular once investors began to see the benefits of low costs, liquidity, and tax efficiency. Over the past 30 years, ETFs have grown in terms of dollars invested. They have also expanded into a broad spectrum of motifs, or investment themes. At the end of 2022, according to data from Statista, there are over 8,700 ETFs across the globe managing assets of almost 10 trillion U.S. dollars.

Since the introduction of ETFs, access to further customization in stock and bond exposure has been enhanced and widened to different ranges of capital market participants. The ability for high-net-worth clients to further customize their equity exposure and enhance their tax efficiency, all while maintaining a professionally managed portfolio, has been an appeal to the separately managed account (SMA) structure over the past few years.

Separately Managed Accounts

Separately Managed Accounts (SMAs) were created to provide investors with customization and control that is inaccessible in an ETF, in which all investors have the same risk, return, and exposure objectives. Think of an ETF as a “one size fits all” approach, while an SMA provides a tailored fit.

In an ETF, investors own shares of the ETF, which in turn owns the individual securities. In an SMA, the investor directly owns the individual securities within their portfolio. SMAs are investment accounts that are individually managed by a professional investment manager, typically for high-net-worth individuals. The manager invests the account's assets in a diversified portfolio of securities, typically including stocks, bonds, and other assets. Unlike mutual funds and ETFs, the SMA portfolio is customized to the individual investor's needs and goals, and the manager has the discretion to make individual investment decisions within the account. SMAs typically have higher fees than mutual funds and ETFs due to the personalized management and attention given to the account.

We believe Separately Managed Accounts (SMAs) offer several advantages over other types of investment vehicles, including:

1. Customization: One of the key advantages of SMAs is that they offer a high degree of customization. Unlike mutual funds or exchange-traded funds, SMAs are tailored to meet the specific needs and investment objectives of individual investors. This means that the investment manager can take into account a client's risk tolerance, tax situation, and other factors when constructing the portfolio.
2. Transparency: SMAs offer greater transparency compared to mutual funds or ETFs. With SMAs, investors can see the individual securities that are held in their portfolio as well as any transactions made on their behalf. This level of transparency can help investors to better understand their investments and make more informed decisions.
3. Control: SMAs give investors greater control over their investments. Because the account is managed on an individual basis, investors can make changes to the portfolio to meet their specific needs or objectives. In addition, investors can usually choose to restrict investments in certain companies or industries that they don't want to support.
4. Tax Efficiency: SMAs can be more tax-efficient than other types of investment vehicles. Because the account is managed on an individual basis, the investment manager can take into account the client's specific tax situation and make investment decisions that minimize taxes. For example, the manager can use tax-loss harvesting strategies to offset capital gains and reduce the investor's tax liability. SMAs also allow investors to hold on to highly appreciated securities, building a portfolio around these legacy holdings, allowing the client to forgo selling them to be on strategy and incur taxes.
5. Professional Management: SMAs are managed by professional investment managers with the expertise and experience to make informed investment decisions. These managers often have access to research and analysis that individual investors may not have, which can help them to make better investment decisions.

Overall, SMAs can offer a high degree of customization, transparency, control, tax efficiency, and professional management that may not be available with other types of investment vehicles.

A Bespoke Approach

Index mutual funds and ETFs are similar in their objective of tracking the performance of a particular index but differ in their structure and method of trading. SMAs, on the other hand, offer a more personalized investment approach with potentially higher fees due to the customized management.

Every investor approaches the capital markets with different goals and objectives. While some might be looking for capital preservation and income, others might be seeking growth and appreciation of their dollars. At Balentine, we create bespoke client portfolios, strategically utilizing vehicles such as Index Mutual Funds, ETFs, and SMAs to meet each client’s individualized needs. Read more about the specific benefits of SMAs here.

If you’re curious about how these instruments could be a part of your personal financial plan, please reach out to a relationship manager.

‍

Balentine LLC (“Balentine”) is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Balentine’s investment advisory services can be found in its Form ADV Part 2, which is available upon request. This information has been prepared by Balentine LLC (“Balentine”) and is intended for informational purposes only. This information should not be construed as investment, legal, and/or tax advice. Additionally, this content is not intended as an offer to sell, or a solicitation of any investment product or service. This information is confidential, for one-on-one use, and should not be redistributed to anyone who is not the intended recipient.