Neuberger Bergman: Four Reasons To Reconsider Custom SMAs

The Wealth Advisor Contributor

November 15, 2024

Historically, the discussion around direct indexing’s rise in popularity has centered upon technology improvements and lower transaction costs. While those two themes are still relevant, other trends may lead advisors and clients to find value in custom separately managed accounts (SMAs) across their equity investments.

Trend	Impact
1. The highest tax rates in the U.S. exceed 30% for long-term capital gains and 50% for short-term capital gains. When looking at historical rates, these do not approach all-time high tax rates, which speaks to the potential for future increases.	If clients realize a $100 gain on an investment at a 50% tax rate on short-term capital gains, they are only able to reinvest $50 after paying taxes. This is one of the greatest drags on investment returns. Should tax rates increase, this only becomes a greater headwind for clients. A systematic, tax-managed approach of realizing losses and deferring gains can potentially provide 1 – 2% of annual tax benefit versus a core benchmark. In active equity models where the Portfolio Manager’s objective is to create pre-tax alpha, the consideration of taxes can provide an even larger after-tax benefit, potentially greater than 3% per annum versus an active equity model.
2. A McKinsey study in 2021¹ produced three key metrics to highlight the importance of personalization for businesses today: 75% of consumers switched to a new store, product or buying method during the pandemic 71% of consumers expect companies to deliver personalized interactions, and 76% get frustrated when this doesn’t happen Companies that grow faster drive 40% more of their revenue from personalization than their slower-growing counterparts	Given the rising focus on personalization, it should be expected that clients will want the same from their investment portfolio. Within investments, personalization can take many forms: Avoid purchasing more of a stock the client holds from their employer Removing a sector or business category the client does not want to hold Managing according to clients’ specific tax liabilities This toolkit can help advisors show more flexibility for understanding and implementing their client needs. Doing so with a partner that offers scalability will enable a more efficient, and potentially more profitable, advisory business.
3. The advisory world is in a period of significant change due to advisor succession planning. Within the next 10 years, 37% of advisors controlling $10.4tn, or 40% of total industry assets, are expected to retire.²	For advisors taking on clients through succession planning, providing a seamless transition with a clear value proposition will be key. This may include: Access to an array of investment exposures, whether it be active, core or systematic, which can help better align with existing investment goals or help solve for new client objectives Ability to perform tax-efficient transition analysis can show clients how to potentially avoid a large tax bill when making an investment change Offering new benefits such as after-tax reporting, charitable gifting analysis or an ESG investing toolkit, all while improving scalability within their overall advisory business
4. We are in the midst of a significant transfer of wealth from Baby Boomers to Millennials and Gen Z: $84tn is anticipated to move between generations by 2045³ 70% of U.S. affluent household investible assets are controlled by Baby Boomers⁴ 80% of heirs fire their parents’ financial advisor after they receive inheritance⁵	It has never been more important for advisors to be meeting with all family members to identify their overall investment objectives and plan for the future. To do so, an advisor needs a way to personalize investment solutions, and a scalable approach so they can continue to spend the majority of time directly engaging with clients. Scenarios may include: A desire to combine new and existing assets in a tax-efficient manner Individual family members wanting to incorporate personal values into their investment portfolios A family member believes in value factor investing

Trend

Impact

1. The highest tax rates in the U.S. exceed 30% for long-term capital gains and 50% for short-term capital gains. When looking at historical rates, these do not approach all-time high tax rates, which speaks to the potential for future increases.

If clients realize a $100 gain on an investment at a 50% tax rate on short-term capital gains, they are only able to reinvest $50 after paying taxes. This is one of the greatest drags on investment returns. Should tax rates increase, this only becomes a greater headwind for clients.

A systematic, tax-managed approach of realizing losses and deferring gains can potentially provide 1 – 2% of annual tax benefit versus a core benchmark. In active equity models where the Portfolio Manager’s objective is to create pre-tax alpha, the consideration of taxes can provide an even larger after-tax benefit, potentially greater than 3% per annum versus an active equity model.

2. A McKinsey study in 2021¹ produced three key metrics to highlight the importance of personalization for businesses today:

75% of consumers switched to a new store, product or buying method during the pandemic
71% of consumers expect companies to deliver personalized interactions, and 76% get frustrated when this doesn’t happen
Companies that grow faster drive 40% more of their revenue from personalization than their slower-growing counterparts

Given the rising focus on personalization, it should be expected that clients will want the same from their investment portfolio. Within investments, personalization can take many forms:

Avoid purchasing more of a stock the client holds from their employer
Removing a sector or business category the client does not want to hold
Managing according to clients’ specific tax liabilities

This toolkit can help advisors show more flexibility for understanding and implementing their client needs. Doing so with a partner that offers scalability will enable a more efficient, and potentially more profitable, advisory business.

3. The advisory world is in a period of significant change due to advisor succession planning. Within the next 10 years, 37% of advisors controlling $10.4tn, or 40% of total industry assets, are expected to retire.²

For advisors taking on clients through succession planning, providing a seamless transition with a clear value proposition will be key. This may include:

Access to an array of investment exposures, whether it be active, core or systematic, which can help better align with existing investment goals or help solve for new client objectives
Ability to perform tax-efficient transition analysis can show clients how to potentially avoid a large tax bill when making an investment change
Offering new benefits such as after-tax reporting, charitable gifting analysis or an ESG investing toolkit, all while improving scalability within their overall advisory business

4. We are in the midst of a significant transfer of wealth from Baby Boomers to Millennials and Gen Z:

$84tn is anticipated to move between generations by 2045³
70% of U.S. affluent household investible assets are controlled by Baby Boomers⁴
80% of heirs fire their parents’ financial advisor after they receive inheritance⁵

It has never been more important for advisors to be meeting with all family members to identify their overall investment objectives and plan for the future. To do so, an advisor needs a way to personalize investment solutions, and a scalable approach so they can continue to spend the majority of time directly engaging with clients.

Scenarios may include:

A desire to combine new and existing assets in a tax-efficient manner
Individual family members wanting to incorporate personal values into their investment portfolios
A family member believes in value factor investing