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Although Separately Managed Accounts (SMAs) have seen tremendous growth in recent years—and gained greater attention from investors—they have been around since the 1970s. These vehicles were originally developed to bring institutional-quality investment management to the individual investor. Previously, retail investors could gain access to broad diversification and professional management via mutual funds, but separately managed portfolios of individual securities were only available to investors that could meet institutional minimums.

Through an SMA, individual investors can access institutional-style professional management with much lower minimums (typically $100,000, for example, in the case of equity portfolios). Compared to investing through a mutual fund, some of the potential benefits of an SMA that come from individual security ownership include:

  • Increased transparency of portfolio holdings.
  • Flexibility to customize portfolios.
  • Ability to implement security and industry restrictions.
  • Greater control over tax planning.

Given these attributes, it may be surprising to some to see the growing trend of certain SMA portfolios including mutual funds as a key element of their strategy. These funds, also known as completion portfolios, are designed to serve specific functions within an SMA.

Here, we offer more details about completion portfolios, how they work, and their potential benefits to SMA investors.

What are completion portfolios?

Completion portfolios are no-fee mutual funds that are designed and managed exclusively to be a component of an SMA portfolio. They are registered with the SEC under the Investment Company Act of 1940 like any other mutual fund but are only available to the manager of the SMA portfolio. Completion portfolios are not available to be purchased or sold by any other investor. These funds can provide portfolio diversification and access to certain securities that are not typically included in SMA strategies, at no additional cost to the investor.  

Why would an SMA strategy benefit from a completion portfolio?

While pooled investment vehicles like mutual funds can hold hundreds, if not thousands of securities, an individual SMA tends to have a much smaller number of positions. For example, a high-quality municipal bond strategy (investing in bonds rated ‘AAA’ through ‘A’) can achieve sufficient diversification with a portfolio of as little as 10 to 15 holdings.

However, history shows there are tremendous opportunities in bonds rated ‘BBB’ and below, which not only offer higher tax-free income, but have delivered much higher total returns over the long term.1 In order to achieve prudent diversification when investing in lower-rated credits, the portfolio would need a much larger number of holdings than are typically found in an SMA strategy.

Even among higher-rated securities, SMA portfolios tend to focus on larger, more liquid issues, as they may be required to sell odd-lot positions to meet redemption requests. Completion portfolios allow investors to access high-quality issues with enhanced yield and total return potential that might not have the liquidity profile to be included in an SMA portfolio. 

How are these strategies managed?

SMA portfolios that include completion portfolios are managed in a holistic manner, targeting overall portfolio exposures for yield curve, credit quality, and sector positioning. For example, the Lord Abbett Enhanced Intermediate Municipal Bond SMA strategy includes a portfolio of high-quality individual municipal bonds (rated A- or higher) along with a completion portfolio consisting of a diversified selection of more credit-sensitive municipals. This approach can enable a professional manager to deliver to SMA investors an investment solution more typically found in a mutual fund.

Clients could benefit from the transparency, tax efficiency, and customization options from the individual bond holdings, as well as the higher income, potential total return, and diversification benefits of the completion portfolio.

Are completion portfolios only beneficial to municipal strategies?

Completion portfolios can be valuable additions to many SMA investment strategies. Within taxable fixed income, for example, individual positions in SMA portfolios are largely limited to U.S. Treasuries, U.S. government-related securities, and certain segments of the high-quality corporate and asset-backed securities (ABS) markets. The addition of high yield exposure could enhance yield and total return in these high-quality portfolios, but as noted earlier, proper diversification in the high yield corporate bond market would require a large number of holdings. Meanwhile, certain segments of the high yield market may have minimum trade sizes or might not have the proper liquidity profile to trade odd-lot sizes in SMA accounts.

In addition, a large and growing part of the taxable bond market (corporate bonds, securitized sectors, and convertible securities) is now issued under the U.S. Securities & Exchange Commission’s Rule 144a, meaning that such securities are only available to qualitied institutional investors. While securities covered under this rule are commonly found in mutual funds, they are not registered for sale to individual investors. Completion portfolios can allow access to this broader opportunity set; the enhanced diversification and yield of these sectors can help deliver core-plus or multisector bond strategies within an SMA portfolio.