Individually Managed Accounts for Affluent Investors

Understanding Why the Rich Tend to Prefer an Individually Managed Account

If you are an affluent or high net worth investor, you almost assuredly have heard about something known as, or know several people around you who have, an individually managed account, or IMA. If you haven't heard of one, it isn't particularly surprising because an individually managed account is generally not available from any of the more well-heeled institutions to anyone with less than $100,000 in investable assets.

In fact, firms set the limit much higher with $1,000,000 to $10,000,000 not being particularly unusual.

What is an individually managed account? Why do certain asset management companies offer them? What are the benefits and why do so many people in the economic upper class have one? Those are great questions. I thought it might be a good time to sit down and explain these specialized investment tools as they've been on my mind lately with the upcoming launch of my private family office and global asset management firm.

How an Individually Managed Account Works

Perhaps the easiest way to understand an individually managed account if you are unfamiliar with the concept is to think about how a mutual fund is structured. You buy shares, the company or trust (the fund itself) takes that money and the portfolio manager hired by the board of directors or trustees, depending on the specifics, then allocates that capital according to the fund's mandate; whether it be buying blue chip stocks in Europe or following the rules of a stock market index such as the S&P 500.

The portfolio manager is paid the management fee, the custodian takes a (usually comparably tiny) fee, and you are able to achieve widespread diversification without a lot of time or effort.

This whole arrangement is wonderfully beneficial provided the fund is shareholder-friendly but there are some downsides.

The odds are good you'll never meet the portfolio manager; you may not even know his name or what he looks like. The portfolio can't be customized to your own unique needs or tax situation. Under some weird circumstances, you could end up getting slammed with huge tax payments even if you lost money on a fund. You have to worry about the index methodology being secretly changed to your (in my opinion) detriment. You can probably think up at least half a dozen other objections.

With an individually managed account, these issues can be solved.  Instead of buying into a mutual fund or index fund, you open a global custody account at a bank trust department or registered broker-dealer. You then sign an advisory contract with the portfolio manager's Registered Investment Advisor firm directly. The details of the contract will depend on a lot of things - many will charge an outright annual fee, which can be tiered or flat, expensive or inexpensive, charged in advanced or charged in arrears. Others may agree to a performance fee arrangement (also known as "fulcrum fees") where they take a percentage of profit (an option that is only available by order of the SEC if you, the investor, pass several high hurdles, including a minimum investment of $1,000,000 with the particular advisor or a net worth of $2,000,000 excluding your home).

As part of the advisory contract process, you grant the portfolio manager discretionary authority over the custody account. That is, he, she, or they (in the event it is a committee of a few people) are given the power to place trades on your behalf; to assemble the portfolio of stocks, bonds, or whatever other securities your portfolio policy document and investment mandate may have spelled out during the start of the relationship. You go about your life, just as you would with a mutual fund, in many cases not even seeing the trades until you get your statement. When that statement does arrive, you won't see "XYZ Fund", you actually see the underlying holdings. The veil between you and the individual stocks - and never forget that all equity mutual funds including index funds consist of individual stocks as the fund itself is a legal structure, not an investment (there is no such thing as "I don't own individual stocks", it's simply a matter of the methodology utilized to select those stocks) - is removed.

You see beneath the hood to underlying economic reality.

Determining the Mandate for Your Individually Managed Account

The investment mandate of your individually managed account can vary wildly depending on the firm or portfolio manager you select. If you find a traditional, old-school value-based group, like my family office will be, you're probably going to end up with low-turnover, long-term, mostly passive holding, a desire for maximizing tax efficiency, and a focus on ensuring a margin of safety so positions are backed by intrinsic value, even if market value is lacking at the moment of acquisition. There are other firms where you might get rapid-turnover, momentum investing that causes you bounce from position to position every few months as you attempt to scry meaning from charts (even typing that fills me with contempt but there are people who do that sort of thing despite the enormous frictional costs and loss of deferred tax benefits). There are firms that specialize in religious investing, removing things like tobacco or pharmaceutical stocks (due to the potential ties to abortion). There are firms that specialize in putting money to work in certain parts of the world, staffed with analysts who can actually read the local language and are trained in non-GAAP financial statements.

To put it another way: If you desire it, the chances are good that it exists out there somewhere, for better or worse.  You can be as conservative or as speculative as you want. There are individually managed accounts that will only accommodate fully-paid, non-margined, dividend paying stocks and those that will employ obscene amounts of leverage, shoot for the moon, and pray they hit pay dirt (along with the three-inch-thick stack of disclosures to explain the risks you are taking).

Reasons an Individually Managed Account Is Often Superior to the Alternatives

There is a myriad of reasons individually managed accounts are often the best option for those with significant assets; with the financial resources and success to make the most of the arrangement. These include, but aren't limited to:

  1. Greater gifting and tax efficiency. Whether you want to sell assets to raise cash or the portfolio manager wants to offset a gain on a successful position so more net capital remains in the account, with an individually managed account you can engage in a strategy known as tax harvesting. Done correctly, tax harvesting can add nicely to your overall after-tax rate of return, which makes a considerable difference when you stretch into longer periods of time, especially if you are in a higher tax bracket. You might also want to transfer specific blocks of stock to charity or a charitable remainder trust, or gift them to your children or other family members. An individually managed account makes it a lot easier to arrange it in a way more goes where you want and less to the tax man.
  2. The ability to take ethical and moral considerations into account. As already touched upon briefly, it causes some people considerable stress to know that they are profiting from things like selling cigarettes or abortifacients through their index funds. Still others don't want to own weapons manufacturing plants or oil drillers. With an individually managed account, that concern can largely be washed away with almost no effort.
  3. The ability to customize risk exposures and offset personal situations that are unique to you and your family. Let's say you are debt-free and want to create a backup stream of passive income yielding 4% per annum to protect your family in case you lose your job. Or, maybe, you are a co-trustee of a trust fund you inherited but don't want to take any of the corpus out for asset protection reasons; you want the trust itself invested in assets that pay no dividends so there is no income tax owed at the trust level (going back to the tax efficiency we discussed earlier) but you can't sleep well at night unless you know the firms in which you hold equity are financially rock solid with great balance sheets (there will be no airline stocks for you!). Perhaps you are planning on moving to Germany for retirement and want to reduce currency risk in the interim so you know you'll be able to afford a place to live using the dividends, interest, and rents produced by your portfolio. This sort of thing is easy with an individually managed account. Whatever your situation, your money can be put to work for you far more efficiently than it could through another mechanism.
  4. The human touch. You can pick up the phone or send an email and talk to the actual person responsible for overseeing your wealth. You can ask questions, sit down and have a cup of coffee, and even come up with a strategy to make your money work better for your own objectives. It's not the same as dealing with another random person at a call center. It's entirely possible the person you work with throughout most of your career may be helping your children and grandchildren manage their individual account someday.

Whatever your reason, it isn't an accident that many investors who are educated, sophisticated, and have a seven or eight figure net worth end up with some sort of personalized financial services plan, which can often include an individually managed account.