Advisory Blog
Setting the record straight on investment-grade corporate bond SMAs

Timely insights on the issues that matter most to investors.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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      By Thomas H. Luster, CFADirector of Quantitative Strategies, Investment Grade Fixed Income, Eaton Vance Management

      This is the first of a series of blogs highlighting the unique advantages of investing in fixed-income through a separately managed account.

      Boston - Recent articles in the financial press have touted commingled vehicles — both mutual funds and ETFs — as the best way for individuals to invest in high-quality corporate bonds. As one of the world's leading providers of separately managed accounts (SMAs), we respectfully disagree. In trying to make their case, the authors of these articles tend to overstate the benefits of commingled products while failing to acknowledge the advantages of SMAs.

      Buying in bulk isn't what it used to be

      One of the main arguments used in favor of mutual funds and ETFs is that their size gives them purchasing power. It's true that transaction costs are generally still lower for large blocks of bonds than for smaller lots. However, the rise of electronic trading platforms has made it possible to source small positions at very attractive prices. We have ample data showing highly efficient execution for smaller trades that rivals the execution efficiency of much larger transactions. These electronic exchanges have also made it easier for SMA managers to locate specific bonds to fit specific mandates. SMAs are bespoke portfolios, customized to each client's needs and preferences — an important distinction versus funds.

      SMAs are professionally managed, too

      Champions of bond funds emphasize the value of professional management. This includes the execution of corporate actions and, for actively managed funds, credit oversight and the ability to analyze securities with embedded options. There is actually very little optionality in the investment-grade corporate bond market, so this point is somewhat moot. Furthermore, SMA managers (like active bond managers) can avoid owning securities with calls or puts. The larger issue is that most individual investors do not have the expertise and resources required to successfully manage fixed-income portfolios for themselves. On this point we agree with bond-fund advocates, although we fault those who exclude SMAs when discussing the merits of professional management.

      Of course, investors in index products forego the benefits of credit analysis — analysis that is especially critical now that we are closer to the end of the U.S. credit cycle than to the beginning. In particular, markets have become fixated on the potential vulnerability of BBB-rated securities, a quality tier that has grown rapidly since the financial crisis and currently represents nearly 40% of the U.S. investment-grade corporate bond market, according to the BofA Merrill Lynch Corporate Master Index as of June 2019. We believe rigorous credit oversight with a focus on downside principal protection should be a foundational element of any fixed-income allocation.

      SMAs have an edge in key areas

      We mentioned customization earlier, and there are other advantages that SMAs have over pooled vehicles. SMAs are fully transparent and more tax-efficient, with the ability to generate tax losses for individual clients in a disciplined, ongoing fashion. And unlike investors in mutual funds and ETFs, investors in SMAs can't be whipsawed by the trading activity of their co-investors.

      Bottom line: The view that commingled products are the best choice for individuals seeking exposure to high-quality corporate bonds ignores the opportunity in SMAs. Electronic trading platforms have made it much more cost-effective to buy smaller positions. In addition, SMAs provide investors with professional management and the added benefits that come with direct ownership of securities in a standalone portfolio.