#$schm

Salsbury Cove, ME asks...How Does an SMA Work?

This is one of those questions we answer frequently -- glad you asked!

“SMA” stands for Separately Managed Account, and it refers to a portfolio of assets managed by an advisor or a money management firm. Perhaps the easiest way to understand SMAs is to think of them in contrast to mutual funds. A mutual fund is comprised of various types of securities (stocks, bonds, REITs, etc.) that are maintained by a portfolio manager. An investor does not actually own shares of the underlying securities in the fund. Instead, you own shares of the mutual fund itself, which is priced at the end of each day using a ‘net asset value’ (NAV).

By contrast, a Separately Managed Account typically has an investment manager build you a custom portfolio using your assets to buy stocks, fixed income instruments and so forth in accordance with your goals. It’s almost as if the manager is building you your own mutual fund, except you own shares of each security and you can generally customize it however you’d like. If the portfolio manager purchased shares of Nike, Inc in your account, but you don’t like that company, you can remove it from your portfolio. You can’t do that in a mutual fund.

There are a couple of advantages to having a Separately Managed Account:

Customization – when a mutual fund is created and managed, it’s not done specifically with your investment objectives in mind. SMAs can be constructed according to your goals and preferences, and managed dynamically with your changing financial situation. Mutual fund managers don’t know anything about your goals – they are simply managing according to a set investment mandate or asset class, like ‘large cap growth.’

Tax Efficiency – SMAs allow the portfolio manager more flexibility in controlling gains and losses for the individual investor. Since you own each security in your portfolio directly, you have more options for how you harvest gains and losses. In a mutual fund, the portfolio manager is making trades in the fund for tactical reasons but also to handle redemptions, and the investor generally has to absorb whatever capital gains taxes occur as a result.

It’s also possible that SMAs can have competitive fee structures when looked at side by side with a mutual fund, but it really just depends on the money manager and which mutual fund you’re comparing.

I won’t go as far to say that SMAs are more advantageous than mutual funds. They are just different. In general – but not as a rule – mutual funds are better suited for investors with smaller amounts to invest, say $100,000 or less. The mutual fund can give that kind of investor broad diversification in one vehicle. With $100,000 or less, SMAs could present some diversification challenges. Amounts above that, however, can give the portfolio manager greater ability to spread assets around various securities and build a diversified portfolio.

If you're thinking about a Separately Manager Account, and want to know some good questions to ask a prospective money manager, read "What to Look for in a Money Manager."  This guide provides 10 tough questions you can ask as well as notes on what to look for in responses relative to your needs and mind-set for investing...

FREE GUIDE:  “What to Look for in a Money Manager”

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The Mid-cap 400 is one of the more important market indexes that we look at. I tend to call them the “Jan Brady” of the major US Averages because they are often ignored in favor of either the Large-Caps or the Small-Caps. They’re stuck in the middle. But companies that fall in this category, with market caps between $2B-$10B can tell us a lot about the direction of US stocks as a group. Based on what we’re seeing, the Mid-Caps are telling us US Stocks should continue to hit new highs as a whole. Let’s break it down:

Since September, we’ve preferred to stay away from Mid-caps (See Sept 14th and  Nov 24th). We haven’t seen the point in getting involved after they hit our initial target and some consolidation seemed necessary. Well we’ve now gone nowhere over the past 6 months, which is not necessarily a bad thing. I think the fact that the Mid-Cap 400 has hung out up here digesting gains sideways, rather down through a downside correction is very healthy and a breakout is imminent.

Here is a daily Candlestick chart looking at this consolidation over the past several months. I see higher lows and higher highs with very well-defined overhead supply:

This is a name we want to own above all of this resistance. Above the December highs and there is nothing but blue skies. Our target based on this potential breakout would be up near 285 based on the 161.8% Fibonacci extension of the September/October decline. This represents about 6% of upside from current levels. I think we get a breakout soon and we want to be all over it.

Normally it’s either the Large-Cap Indexes like the S&P500 and Dow Industrials or the Small-Cap Russell2000 that get all of the attention. But there is a whole other universe of stocks that are stuck in the middle; not big enough to be a Large-Cap nor small enough to be a Small-Cap. These Jan Brady Mid-Caps are stocks with a market capitalization between $2B and $10B. Names like 3D Systems $DDD, Foot Locker $FL and Cheesecake Factory $CAKE fall into this category.

We start with a weekly logarithmic candlestick chart of $MDY for a more structural perspective and work our way down to the near term for execution and risk management. Here we can see that in July prices of the Mid-Cap ETF broke a major uptrend line from the 2009 lows. This broken uptrend line that had served as support for so long now appears to be turning into resistance:

I would not want to own this as long as prices remain below that key uptrend line. At least not for now.

Next we are looking at a daily candlestick chart of $MDY with a 14-day relative strength index as a momentum reading. We can see that in early September Mid-Caps failed to exceed the July highs running into resistance and putting in what could potentially be a double top:

Another problem that I see here is that on this month’s highs, momentum put in a bearish divergence. This is not a good combination and suggests that the bears have the better risk/reward here. We would no longer want to be short above that 264 level that has been trouble over the last few months.

Over the short-term, that 254 level looks like it should serve as support. This level was resistance back in March and April, then turned into support during July. The bulls really need to step up and control that level, otherwise, things could get ugly.

A rising 200-day moving average also favors the bulls. It’s hard for markets to have steep corrections with upward sloping smoothing mechanisms like that. I would become much more neutral towards this market as we approach that moving average and support from August, then reevaluate the situation.

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