Portfolio Perspectives: Finessing Custom High-Net-Worth Strategies

March 22, 2024

By Lucas Felbel, CIMA®, Director, Portfolio Services

Wealth management has undergone a significant transformation over the past decade. Exchange-Traded Funds (ETFs) have emerged over mutual funds as the preferred investment vehicle suitable for most investors, and the proliferation of separately managed accounts (SMAs) offer unique solutions for complex client situations, democratizing strategies once exclusive to the ultra-wealthy and institutional investors. In this evolving landscape, financial advisors have more tools at their disposal than ever to enhance clients’ investment outcomes. The challenge lies in integrating these diverse options into a cohesive, diversified strategy that maximizes benefits while mitigating risks.

The Problem

With a deep bench of ETF model portfolios and SMA offerings, Dynamic’s asset management team regularly encounters inquiries from advisors on combining these strategies into a customized High-Net- Worth (HNW) client approach:

“Won’t using an S&P 500-tracking direct indexing SMA combined with a model portfolio overexpose my client to US Large Cap?”

“If the client only uses an actively managed state-specific municipal bond SMA for fixed income, do we lose the benefits of diversification in our bond allocations?”

“Don’t SMAs disallow multiple parties trading in the same account and how does that work in combination with a Dynamic model?”

Advisors are keenly aware of the complexities and potential pitfalls associated with leveraging SMAs in client portfolios. The level of skill and technology required to successfully marry two or more separately operating strategies traded by multiple parties into a unique, customized solution is rare. For years, Dynamic’s team has partnered with advisors on thousands of unique client situations. As Dynamic’s investment solutions lineup has grown so has our advisors’ ability to leverage our portfolio management team’s capabilities to serve a more complex client requiring sophisticated solutions.

The Solution

Incorporating an SMA strategy into a HNW client portfolio should not be viewed, nor executed, as a haphazard addition to a portfolio. For the client to realize the full benefits of the strategy, the SMA must be a mindful, intentional deployment considering all aspects of the model and SMA combination. The merger between model and one or more SMAs should not overexpose the client to a specific asset class or undermine the investment philosophies embodied in model portfolio solutions. SMA usage should serve to enhance a model’s valuable properties in the creation of a tailored strategy.

Advisors who leverage Dynamic’s asset management team’s in-depth knowledge of our solutions lineup realize the full benefits of using SMAs in combination with our ETF model portfolios. Dynamic’s Custom HNW experience ensures that a client’s SMA is proportionally implemented according to the appropriate asset class exposure in the customized ETF plus SMA strategy, and (just as importantly) that this exposure is correctly managed and maintained in relation to the overarching strategy.

Meaning, that when an SMA’s proportion (ex. Dynamic Custom Indexing using an S&P 500-tracking index) is under or over tolerance to the related exposure in the overall strategy (ex. US Large Cap), assets will be redistributed throughout the multi-account portfolio in a tax-efficient manner to maintain the overall strategy’s SMA and ETF position tolerances.

Execution of complex custom HNW strategies still require SMAs remaining in their own separate accounts, as their name implies. Housing an SMA in its own account allows it to maintain its special properties, professional oversight and unique third-party execution, though the SMA is still managed in relation to a multi-account portfolio incorporating a customized ETF model. Problems solved.

To illustrate:

A business owner with a $5 million portfolio and a risk exposure matching an overall 60/40 is looking to diversify assets and minimize the upcoming tax impact of selling their business in the next five years before retiring. The advisor recommends allocating $1 million to a direct-indexing strategy tracking the S&P 500 to provide the best opportunity for continuous tax-loss harvesting over the next five years to mitigate taxes with carryforward capital losses in anticipation of the sale of the business.

Approximately 30% of an industry-standard 60/40 portfolio is allocated to US Large Cap equities. Using a non-customized 60/40 model for the $4 million, plus an S&P 500-tracking direct indexing SMA for $1 million, would overexpose the portfolio to US Large Cap and put the client over their risk tolerance. Alternatively, if a lower equity ETF model is used for the $4 million, then the portfolio loses diversification benefits. Two large concerns.

To solve for both potential overexposure and diversification concerns, the US Large Cap allocations in the ETF model are reduced proportionally to the deployment of the SMA. If 30% of a 60/40 model is US Large Cap (30% x $5 million = $1.5 million) and $1 million of the $5 million portfolio is being used for the S&P 500-tracking direct indexing SMA ($1 million/$5million = 20%), then the standard ETF model exposure to US Large Cap will be reduced by the SMA dollar amount, leaving approximately $500,000 remaining allocated to US Large Cap holdings in the ETF model (30% – 20% = 10%, $5 million x 10% = $500,000).

Simply put, the SMA replaces a proportionate amount of the overall custom strategy using model ETFs to round out asset class exposures maintaining the integrity of the solution while leveraging the exclusive characteristics of the SMA.

Typically, more than one account is used to make up client portfolios with separate accounts being used for separate reasons as part of the overall financial plan. Maintaining separate accounts for SMAs in HNW solutions will benefit advisors in being able to isolate measurable characteristics of the individual strategies deployed, while preserving the ability to generate household-level reports on the performance of the overall custom strategy.

The Conclusion

Successful advisors strive to deliver an increasing level of service sophistication to clients for increasing relationship retention, expanding practice capabilities to serve new niches of clientele and enhancing the opportunities to deliver better outcomes. Given the complexity of SMA solution offerings and the pace at which these tools are being made available to a greater population of investors, it strongly benefits advisors to partner with an experienced portfolio management team knowledgeable on piecing together bespoke solutions to benefit their clients. Leveraging a specialized team for HNW solutions incorporating SMAs saves Dynamic advisors hundreds of hours each year and increases the speed in which opportunities for better client experiences can be delivered.

Invest with Intention.

For more information, contact Dynamic’s Investment Management team at (877) 257-3840, ext. 4 or investmentmanagement@dynamicadvisorsolutions.com.

As Director, Portfolio Services, Lucas Felbel, CIMA®, leads the implementation, monitoring and evaluation of trading activities at Dynamic Advisor Solutions.


This commentary is provided for informational and educational purposes only. The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. This is not intended to be used as a general guide to investing, or as a source of any specific recommendation, and it makes no implied or expressed recommendations concerning the manner in which clients’ accounts should or would be handled, as appropriate strategies depend on the client’s specific objectives.

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