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Introduced in 1993 with the launch of the SPDR S&P 500 trust, exchange-traded funds quickly became a Wall Street darling. These newcomers took the benefits of mutual funds to the next level by offering investors index exposure — spanning the S&P 500, MSCI World Index, Russell 1000 and more — and a high degree of diversification at low cost. As such, their ascent was nothing short of meteoric, translating to what is now a $5.3 trillion global market (of which U.S. assets account for some $3.7 trillion).
Another investment vehicle that has been attracting increased interest in recent years is the separately managed account (SMA). Comprising a mixture of securities that are overseen by an asset manager, they are similar to ETFs in that they can provide investors with diversified exposure to key indexes and benchmarks. However, SMAs are differentiated in that their holdings can be flexible, tax-optimized and personalized — all while still maintaining a low tracking error to the underlying benchmark. These appealing characteristics have seen SMA assets swell by an astounding 84% since 2010, according to Morgan Stanley.
In the meantime, another trend has burst onto the scene: sustainable investing. The growing interest in this space has precipitated the rollout of numerous ETFs that incorporate environmental, social and governance (ESG) mandates.
Said ETFs have attracted some $1.3 billion in new assets so far this year, but do these "off-the-shelf" products represent the best way to invest for impact? Let's take a look at how they stack up against SMAs.
Alignment With Values
ETFs: Despite their various benefits, ETFs can be somewhat limiting when it comes to investing in accordance with one's values. Many ESG-themed ETFs offer a one-size-fits-all approach, with limited transparency as to what's beneath the hood. And, given the deeply subjective nature of ethical issues, this rigidity can prove problematic.
Most investors simply don't have time to examine their portfolios, and subsequently the plethora of relevant ESG data, to determine whether the holdings therein reflect their values. They are dependent on the issuer's assertion that the fund is, for example, "green," or LGBTQ-friendly. And often, even ETFs that market themselves as "sustainable" utilize such sweeping and disparate selection criteria that investors may find their portfolios include companies whose business practices undermine their views — whether it's energy conglomerates such as Exxon Mobil Corp., tobacco companies such as Philip Morris International, the data scandal-riddled Facebook, or others.
SMAs: SMAs are ideal for values-based investing as they allow investors to actively screen for certain product areas (e.g. oil, tobacco), or "bad actors" that they deem antithetical to their values. They also allow for more specificity, e.g. designating a certain percentage of revenue from carbon emissions to be included in one's portfolio.
Furthermore, because SMA investors directly own the underlying securities, they can opt to play an active shareholder role, working to impact corporate behavior through voting proxies or shareholder resolutions.
Tax Efficiency
ETFs: In some cases, an ETF will distribute capital gains to shareholders. This is not always desirable, as the shareholders are then responsible for paying the capital gains tax.
ETFs, being bundled investments, do not offer tax loss harvesting benefits. Additionally, they can only be funded with cash — which means if an investor is holding securities of another ETF, they will need to sell and purchase with cash.
SMAs: SMAs allow investors to sell stocks at a loss, reducing their aggregate capital gains and subsequently a portion of their taxable income — otherwise known as tax loss harvesting. Because an SMA contains individual securities, capital gains can be offset by selling investments that will produce a capital loss.
Johny Mair is co-founder & chief product officer at 
