Elite Wall Street Firms, Advisors Are Swapping SMAs for ETFs

What You Need to Know

The aim is to exploit the famous tax efficiency of the ETF wrapper, which means funds rarely incur capital gains tax.
SMAs can sell losing positions to offset capital gains incurred by a particular investor but also can quickly run out of losses to harvest.
In ETFs, assets that have gained can be effectively swapped out of funds during the creation-redemption process without a taxable event taking place.

Getting John Beatson to pick stocks for you used to require a cool $25 million or thereabouts. Thanks to the newest trend in money management, these days it’s more like $25.

That’s roughly the price of a share in the Bushido Capital U.S. Equity ETF (ticker SMRI), an actively managed equity vehicle launched by Beatson’s firm Sepio Capital LP last month. It means pretty much anyone can tap him for his stock-picking skills, and even those who don’t invest can see every trade he makes in the ETF given its transparent design.

Sepio is among a small but growing group of elite Wall Street players who are slowly joining the march into exchange-traded funds. Along the way, they’re opening up access to strategies and expertise that for years were the sole preserve of big institutions, family offices and the like — all for a shot at the booming $7.2 trillion arena.

Yet going mass-market is not the primary goal, according to Beatson. The Sepio ETF has launched with around $200 million of existing assets converted from its separately managed accounts, a type of a private investment product commonly used by the wealthy to hold securities directly.

“First and foremost, we want to do this to benefit our current clients,” said the co-chief investment officer. “It’s on average pretty clear, at least with respect to U.S. equities, what the most advantageous structure is for taxable dollars.”

The aim is to exploit the famous tax efficiency of the ETF wrapper, which means funds rarely incur capital gains tax, instead transferring the burden to investors when they exit. That keeps more cash invested for longer, helping funds to earn more.

About $75 billion now sit in ETFs converted from mutual funds, Bloomberg Intelligence data show, following the first ever switch in 2021. They’re mostly chasing that tax advantage, or tapping rampant investor demand for ETFs, which have absorbed hundreds of billions every year as stock mutual funds lose similar amounts.

But the conversion of SMAs like Beatson’s is a newer phenomenon.

ETF Architect, the specialist “white label” firm that helped Sepio through the issuance process, has listed two other ETFs that were converted from SMAs and has around nine similar deals on the way, adviser Wes Gray says. Exchange Traded Concepts, a rival, has “a couple” of SMA conversions coming in the first quarter of 2024, according to Chief Executive Officer Garrett Stevens.

“The wrapper of the future for many in the commingled space will be the ETF,” said Lisa Mantil, global head of the Goldman Sachs ETF Accelerator. “You need to position your strategies and your core strengths as an investment manager and deliver it in the wrapper in which your clients want it.”

Mantil has been surprised by the mix of clients she’s spoken to since leading the creation of Goldman Sachs Group Inc.’s ETF platform late last year.

While about 60% are asset managers, the balance comprises hedge funds, financial advisors, insurers and family offices, she said. Goldman has consulted on several debuts so far, including from Grantham Mayo Van Otterloo and Brandes Investment Partners.

Hedge fund switches are rare, even compared with SMA conversions.