As investors increasingly put their money where their values are, the financial industry has responded by rolling out a number of responsible-investing strategies. However, due to the challenges in offering a commingled vehicle, the definition of responsible for these products is meant to appeal to as wide an audience as possible. Because of this one-size-fits-all approach, it’s rare for these products to perfectly reflect the views of any single investor, potentially forcing investors to invest contrary to some of their core beliefs.
Thankfully there’s a solution: customized separately managed accounts (SMAs), which allow responsible investors to construct portfolios that express their unique values without compromising on their investing mandates.
Why should responsible investors use customized SMAs?
Passive SMAs are similar to exchange-traded funds (ETFs) and mutual funds in that they provide broad, index-based market exposure. But the stocks or bonds held in these collective vehicles are fixed, putting investors at the mercy of a manager or index provider’s view of what makes a company good or bad from an ESG perspective. By contrast, SMAs allow investors to choose which securities to own, ensuring their holdings align as precisely as possible with their particular ESG preferences.
This structural difference means SMAs provide a level of flexibility not found in off-the-shelf passive solutions. SMAs give investors full control of their underlying securities, meaning they determine which companies to hold and at what weights. At the same time, risk controls are put in place to ensure the desired market exposure is largely maintained, despite any increased emphasis on good companies in the portfolio.
How to build a customized SMA incorporating ESG guidelines
With an SMA, investors can express their individual ESG views and gain the market exposure they’re seeking through portfolio construction, active ownership, or a combination of the two.
Portfolio construction allows investors to customize their passive exposure, enabling them to own good companies that reflect their ESG principles while excluding bad companies that conflict with those principles. This can be accomplished with screens that only include companies with the best ESG track records or characteristics as the investor defines them. Customization can also be achieved through a quantitative integration process, which overweights companies with higher ESG scores while underweighting those with lower scores.