How SMAs Help Optimize Tax Efficiency In Your Portfolio with Cam Iarrobino – Ep 082

Perhaps you’ve heard of Separately Managed Accounts (SMAs) but aren’t quite sure how they work or if they’re only suitable for high-net-worth investors. In this episode, we’ll break down the truth behind SMAs and why more investors are turning to them as a way to gain control, improve tax efficiency, and tailor their portfolios to their unique financial goals.

In today’s podcast, SHP Financial’s Matthew Peck is joined by Cam Iarrobino, Investment Analyst to explain how SMAs differ from traditional mutual funds and ETFs, and why they’ve gained traction in today’s complex market environment. They’ll walk you through the key benefits of SMAs—including transparency, customization, and after-tax yield—and how they can be used to align investment strategies with a client’s overall retirement plan.

In this conversation, you’ll learn the key benefits of SMAs—including customization and after-tax yield—and how they can be used to align investment strategies with a client’s overall retirement plan. You’ll also learn the importance of rebalancing, direct indexing your investments, and how to know when SMAs are (or aren’t) the right fit for you.

In this podcast interview, you’ll learn:

• How SMAs offer greater customization and control compared to mutual funds and ETFs.
• The increased flexibility and efficiency of direct indexing and tax-loss harvesting with SMAs.
• The advantages of incorporating municipal bonds with SMAs and why their favored by SHP Financial.
• The value of tax efficiencies and after-tax yield benefits of SMAs, especially for high-net-worth investors.
• The difference between SMAs, ETFs and mutual funds with minimums, fees and flexibility.
• How SHP Financial evaluates how to implement SMAs into their client portfolios.

Inspiring Quotes

• “Mutual funds and ETFs, they’re really designed for the masses. They’re designed for anybody that just wants to pop a hundred or thousand bucks into this fund. Maybe it’s a one-time thing, maybe it’s a recurring thing. They’re very convenient. Especially in today’s day and age, they’re so accessible. They’re so convenient. They’re just easy, for lack of a better term.” – Cam Iarrobino

•  ”What we really try to do is find three to five managers in a given space. It’s a diligent meeting process. We meet with all of them. We vet them and just kind of assess them from both a qualitative and a quantitative ” – Cam Iarrobino

Interview Resources

• Archway Investment Fund
• AllianceBernstein

[INTERVIEW]

Matthew Peck: Welcome everyone to another edition of SHP Financial’s Retirement Road Map podcast. I’ll be your host today, Matthew Peck. Today, we’re joined by Cam Iarrobino. He’s a chartered financial analyst and he’s here to talk about an interesting area in the market that you might not be aware of, and that is the land of SMAs or separately managed accounts. I think we live in a world of abbreviations and acronyms and things along those lines, and people in our industry are always like, oh, you have to check out this SMA or this REIT or whatever it may be. And we wanted to sort of unpack it today and kind of get into it because of the fact that it is a very interesting tool and a very effective tool for many ways.

People think in terms of mutual funds and ETFs and individual equities, right? But what’s an SMA? And how does an SSMA operate? And what are the fees? And what are some of the benefits? And who’s an ideal candidate for these SMAs, right? So, if you’ve never heard about SMAs, we hope that you’ll find it very informative. If you’re familiar with that space, great. We hope that this will fill in some gaps. But today is all about SMAs.

Matthew Peck: So, without much further ado, I’d like to bring on Cam Iarrobino, and welcome to this hard-hitting podcast.

Cam Iarrobino: Thank you, guys, for having me.

Matthew Peck: So, Cam’s been in the industry now for over six years, and he is a CFA or a chartered financial analyst, which in my opinion is probably the hardest designation to get, especially in the financial and the sort of the analysts and analysis field. But Cam, why don’t you, before you kind of talk about SMAs, share with our audience how you got into the business, how hard was the CFA, I’m dying to know, honestly? And just tell us a little bit about your history.

Cam Iarrobino: Yeah, definitely. So, just throughout high school and frankly, even middle school, I was always best or I found myself always being best at math with numbers, kind of always had a good sense of money I felt like. That kind of naturally steered me towards wanting to do more of a business path in college. So, I landed at Bryant University in Rhode Island which has a pretty good business program. That’s how I landed there. I was lucky to get in and get a good amount of financial aid, so they had a really attractive offering in terms of me wanting to go there.

So, I went there, wasn’t exactly sure what I wanted to do. Like, within the business world, they offer pretty much everything at Bryant, accounting, marketing, operations, management, entrepreneurship, and obviously, finance as well. And eventually, when I started taking the intro to finance course or whatever it was exactly called, because at Bryant, regardless of what your major is or if you’re undecided or whatever, everybody has to do an intro to marketing, intro to this accounting, intro to financial accounting, operational accounting, intro to everything, just you don’t get your feet wet, help you figure out what you want to do, as well as overall make you well-rounded.

And so, yeah, when I started taking the Intro to Finance course, it just really started to click and I realized that, or I had a good idea at least, that I wanted to pursue this further, specifically within the business world instead of like marketing or accounting or different paths. So, I just started taking more. So, I landed on finance, started taking more finance courses. Eventually in my senior year, I was lucky enough, I got accepted into the student managed investment fund at Bryant. It was called the Archway Fund. So, that was a really awesome experience. My senior year, we were managing some real live dollars at Bryant’s Endowment Fund.

Matthew Peck: Oh, it was real live dollars?

Cam Iarrobino: It was.

Matthew Peck: It wasn’t just kind of like monopoly money?

Cam Iarrobino: No, it was real.

Matthew Peck: Which is also, I mean, plenty– nothing wrong with that, but I mean, literally, this was actual dollars, huh?

Cam Iarrobino: It was, yeah. If memory serves, I think at the time, and I think that they have been growing it, like allocating from the endowment more and more to the student managed fund.

Matthew Peck: And were the students just like investing in Domino’s Pizza and like Bud Light? It was that kind of what they– it’s like everyone drink coffee, Starbucks stock, I imagine. Maybe Dunkin Donuts stock because coffee, beer, and pizza kind of was what I would invest in college. It’s only I knew about that time.

Cam Iarrobino: That was a staple of the diet or lack thereof, for sure, at the time. No, I mean, it’s an interesting point you make. There was like two separate paths that you could take within the Archway Fund. There was the equity side and there was the fixed income side. And actually, I don’t even remember why I ended up on the fixed income side.

Matthew Peck: Okay.

Cam Iarrobino: So, we weren’t really touching stocks. But, yeah, so at the time, I think it was roughly like a million that they were managing on the equity side. And then I think half a million on the fixed income side. So, relative…

Matthew Peck: Real-world experience.

Cam Iarrobino: Yeah, real-world experience, real-world dollars. I mean, obviously, relative to any college’s endowment size, it was a pretty tiny sliver for obvious reasons. But yeah, no, it was an awesome experience that really kind of just pushed me more and more to want to pursue the CFA, kind of pursue being in the asset management world. And then Bryant actually graciously gave me a scholarship for level 1 at the CFA in my senior year, which just kind of, again, continued to push me more and more along that path.

So, they paid for, I can’t remember if it was just the exam or also, the exam and the study materials, but either/or they covered some of the costs of level 1 of the CFA, which, again, that just kind of pushed me more and more to do that. So, that was nice. Studied for that, towards the…

Matthew Peck: At the same time, you were in school?

Cam Iarrobino: Yeah, I mean, towards the end of– it was when I was wrapping up senior year and at that point, I was just kind of getting my feet wet with the material. Not diving too deep into it yet, but yes, I’m still, yeah, during senior year. I graduated in May of 2019, yeah, basically six years ago on the dot. And then I took level 1 because if anybody doesn’t know, there’s three what’s called levels, basically three exams to the CFA that have to be done in order. And they get progressively more challenging, more detailed, and less content, more concentrated on specific areas, but higher difficulty level.

But yeah, so I took the first one in December of 2019, luckily passed that. And then I was supposed to take the second one at some point during COVID. I think it was like June of 2020. And then COVID, obviously, disrupted everything which actually worked out for the better for me anyways, because it was going to be a quick turnaround time that I was going to have to take level 2 in because they’ve made a lot of changes to the CFA program by now. It used to be super stringent back as recent as five years ago. There was like one day each year you could take the exam. That’s how it used to be. Thankfully, they’ve made it a lot more lenient now.

But yeah, long story short, my level 2 exam got pushed a couple times because of COVID, which worked out better for me anyways because I ended up having more time to study, whereas before I felt like I was kind of time crunched. So, my level 2 exam kept getting pushed a few times. Eventually took it, luckily passed that one. The jump from level 1 to level 2, most people feel is the biggest difficulty jump. And then started studying for level 3, took that.

Matthew Peck: While working now. So, it was good.

Cam Iarrobino: Yeah, yeah, yeah. So, yeah…

Matthew Peck: I know at a certain point that you had joined a family office in Boston, and so was that during that time that you were in the investment side? So, real quick sidebar, family offices are large investment firms that deal with families. When they say family office, it means a lot of money in one family. The joke is you’ve seen one family office, you’ve seen one. So, they are all very, very unique in their own way. But at the same point, my main point, Cam, is that while working, you were then studying for the CFA.

Cam Iarrobino: Yep, that’s correct. Yeah. I joined my previous firm that Matt mentioned the family office. I joined them. I want to say it was March-ish of 2021, which I think was like a few months away from when– I think I eventually took the level 2 exam in, it was like May of 2021, I think. So then, yeah, passed level 2 my first time, luckily, onto level three. Studied for that for a good amount of time. Unfortunately, failed that one once, which.

Matthew Peck: Yeah, I mean, no shame in that.

Cam Iarrobino: Yeah. I mean, most people who do end up going on to get the charter, obviously, usually fail, at least one of the levels at least once. But yeah, failed that, failed level 3 one time. I found that one to be the most challenging. Most people will find either 2 or 3 to be the most challenging. I found 3 to be the most challenging. Studied harder, took it again, eventually passed it. It was like, gosh, what was it? I think it was like February. I think it was like a year later. It was like February of 2023. I took the exam. Yeah, you don’t find out the results until a couple months after the fact. So, then found out, I think it was like April or May of 2023. I passed. And then you just have to submit some work requirements and some professional recommendations, letters of recommendation, things like that. And that was it. Got the charter, luckily.

Matthew Peck: Which is fantastic. I mean, just the idea that they can never take that away from you. You have that designation and it is of that rigor and that level, and to do all that while working is extremely impressive in my opinion, which is why we kind of poached them a little bit and said, no, we’ve got to come to SHP because we’re looking into this whole SMA thing. So, Cam, what is an SMA? What is a separately managed account?

Cam Iarrobino: Yeah, so the way that I would try to describe it to folks is it’s a different way of owning the same underlying types of securities, right? So, let’s say, let’s just back things up, go real high level. Let’s say somebody wants to own stocks, right? So, you can go into your brokerage account and you can just go and buy stocks if you want, whatever. We’ll just give a couple examples – Apple, Microsoft, Nvidia, whatever they may be. More commonly, you can buy ETFs or mutual funds. ETFs are exchanged traded funds, similar to mutual funds, right? So, you buy Fidelity Contrafund, whatever, Fidelity Blue Chip Growth Fund, iShares, S&P 500 Index, ETF, those funds then own a certain subset of stocks. Sometimes it’s actively managed, sometimes it’s passively managed. It could be anything from all stocks in the world to small healthcare companies in India. I don’t think a product that specific exists, but I think you get the point.

And then another way of owning the stocks or really, most asset classes is the SMA, the separately managed account. So, under that type of approach, you find, or in our case, your advisor finds for you the SMA manager. It could really sometimes be the same managers who are managing the mutual funds and the ETFs. A lot of places do both and they offer both because they feel that there’s benefits to both. Some places just do SMAs and some places just maybe do mutual funds and ETFs.

Matthew Peck: So, I’ll pause there though, Cam. So, just to kind of almost, I really want to highlight that interesting point because here are all these money managers, think Fidelity, Federated, JP Morgan, whenever that may be, I’m just sort of broad brushing here, they’ll offer a mutual fund. So, clients can walk in or go on to their investment account and buy XYZ mutual fund. But that same mutual fund company, I’ll say in this example, Federated, right, who does a lot of value investing, they’ll offer a mutual fund and then they’ll also offer an SMA. And it’s fascinating because I love your point, Cam, but there’s all these different ways of owning stocks and having sort of your portfolio managed. And there are these firms that, again, will offer both. And it’s always fun to kind of compare performance, of course, but why own if literally, an investor can walk in and say, “Okay, I can either buy the mutual fund or I can buy the SMA.” What are the pros and cons with either path?

Cam Iarrobino: Yeah. So, the first thing I would say is mutual funds and, even to an extent, ETFs, they’re really designed for the masses. They’re designed for anybody that just wants to pop a hundred or thousand bucks into this fund. Maybe it’s a one-time thing, maybe it’s a recurring thing. They’re very convenient. Especially in today’s day and age, they’re so accessible. They’re so convenient. They’re just easy, for lack of a better term.

Now, if you have, say, a larger sum of money that you want to give to a manager. And then, well, I guess to take a step back and part of it is– so the fees, the management fee that these companies charge on these products, it has to kind of reflect that, especially on an actively managed mutual fund. They have to account for the fact that they’re going to get a lot of really small bites, for lack of a better term, from a lot of different investors.

So, on a lot of levels, the product is really, again, geared more towards a huge audience in most cases. And they’re not really able to kind of tailor the fee as if somebody was willing to give them a bigger bite size, right? I mean, generally, just in the business world, the more you buy of something, the better price you typically get.

Matthew Peck: Right, Economies of scale, things on those.

Cam Iarrobino: Yeah, economies of scale volume. Yeah. So, if somebody has, say, a couple hundred thousand dollars which is, I mean, a relatively common amount to put into an SMA. In a lot of asset classes, you’d be able to get better pricing on an SMA, a separately managed account. Then, I like to like similar asset class, investing in the same space, actively managed mutual fund.

Matthew Peck: Interesting. Okay, so when investor, and I’ll kind of come back to SHP’s due diligence in how we operate in this space and where we like it and where we don’t like it and things like that. But it’s still staying high level, still staying at the basic kind of early education here. Biggest comparison right now is fees. So, you look at mutual fund versus SMA. There will be a fee difference, and then also a minimum, meaning that SMAs have anywhere from what, say, like $150,000 to $250,000 of a minimum, where you’re not just popping in there $50, you have to have a significant amount of money to get into an SMA, whereas a mutual fund or an ETF for that matter is $50 or $1,000 versus $250,000. Is that accurate, just for our audience’s sake?

Cam Iarrobino: Yeah. Definitely, yeah, yeah. Well put.

Matthew Peck: Okay. So, we have fees, we have sort of minimums, if you will. What other benefits do SMAs have over mutual funds and vice versa?

Cam Iarrobino: Well, there’s a lot more customizability, right? And a good example of that is in the direct indexing space on SMA. So, direct indexing, not to get too in the weeds, but indexing in general, obviously, let’s name a couple of the most widely known indexes, the Dow Jones stock index in the US and also the S&P 500 index in the US. There’s obviously tons of different– especially for the S&P, there’s a ton of different products out there which do an awesome job tracking the S&P 500 and let’s just take whatever the Vanguard S&P 500 ETF and the iShares, the BlackRock. iShares is owned by BlackRock, S&P 500 ETF.

In any given year, I mean, if the BlackRock S&P 500 fund is up or if the S&P is up, whatever, say 16%, the BlackRock or the iShares S&P 500 ETF fund is probably going to be up, whatever, anywhere between 15.95% to 16%. It’s going to follow the index pretty much to 99% or even higher than that correlation because it’s a pretty easy index to follow at this point. Those products have been around for so long.

Same thing for, frankly, really, any S&P 500 fund out there. So, you wouldn’t really ever want to go, it wouldn’t be worth your while to go and seek out an SMA manager in the indexing space, specifically for better performance or lower fee because that space is just so well covered. It’s been around for so long. It’s such a competitive environment, whatever Vanguard’s fund is like three basis points, 0.03%. And iShares is 0.02%, two basis points. So, I mean, whatever.

Matthew Peck: You’re getting a good fee right there. That’s a good charge.

Cam Iarrobino: Yeah. But where SMAs could come in there is, let’s say, somebody says, I really like the idea of owning the S&P 500, great representation of the US market. Super, well diversified. Like, I can just turn on the news, see what it’s doing. But I really just have a problem with the tobacco industry. I think that it’s just killing America. And somebody could even take it a step further and say, I think that frankly, from a performance standpoint, those companies are probably not going to be around or they’re going to be a shell of what they once were 30, 40 years from now, regardless of whether you think that I’m just…

Matthew Peck: As an example, yeah.

Cam Iarrobino: Yeah. As an example, some people may think that, but even if somebody just doesn’t want to own them for the kind of “ESG” morality reasons. If you have enough funds to give to a direct indexing SMA manager, they can create basically a custom index for you. They can say, “All right, we’re going to take the S&P 500 and we’re going to filter out any companies based on this criteria that are involved in the tobacco industry.” You think Philip Morris. Not really my area of expertise, but any others come to mind, Matt or…

Matthew Peck: Oh, that was like British American Tobacco or BAT or something like that.

Cam Iarrobino: Okay, yeah. So, yeah, basically, a custom index can be created for that client. If they have enough, again, funds to put into the SMA, it generally still tends to be a pretty cheap, pretty low expense product because of the scale and because of the technologies that a lot of these managers have. With a few clicks of buttons, they can take the S&P 500 and they can apply some criteria, filter out these stocks. Boom. Apply it to somebody’s account. Now, they own the S&P 500, but have basically taken away whatever it is in the case of tobacco. Maybe just say it’s whatever, 10 companies. Or it could be anything, it could be defense. A lot of people have a bone to pick with the…

Matthew Peck: The oil companies, too, energy companies.

Cam Iarrobino: The list goes on and on. We’re rambling a little bit here about the different industries, but the point is, so now you have your custom index. They take that and they apply it to that person’s account, and then they go into that account and then they buy. Again, money permitting, if there’s enough funds to, number one, meet the minimum, and number two, justify actually going and buying all these companies, now they go and they take that custom index and they apply it to that client’s account and they buy pretty much all the S&P 500 companies, but taken away the ones that they don’t want.

Matthew Peck: So, okay. It’s interesting in the sense of, and I’ll kind of go back to some of the mutual funds that we were talking about earlier. So, as an investor, it’s almost like you want to look at, okay, where do you want to invest? Do you want to invest in value stocks, growth stocks, corporate bonds, government bonds, or municipal bonds, whatever that may be? So, it’s almost that you looked, okay, what sector do I want to be in? And then it becomes a question of, okay, what wrapper should I be in, right? Do I want a mutual fund wrapper? Do I want an ETF wrapper or do I want an SMA wrapper, right? So, you can kind of decide how you want to do it.

And often, as Cam was saying, certain sectors, it’s better just to be in an ETF or a mutual fund. I mean, SMAs really don’t offer too much advantages for certain sectors. And Cam had mentioned just S&P, just the flat or standard index. However, if we do want to start to customize it a little bit, if we do want to say, okay, no, I do want the index, but I don’t want oil and I don’t want tobacco or sin stock is sometimes what they’re referred to, then okay, then we do look into the SMA wrapper, right?

And I kind of like that idea, is the fact that clients, because well, I would say just in general, which I love, is the fact that no matter what you’re looking for, ladies and gentlemen, it’s out there, right? And I do want to talk about how our process, right, because now, let’s say a client comes to us and says, “Okay, I do want to look into direct indexing. I like that idea. I like that concept,” how does an SHP– and so, okay, I’m going to pose this question to you. How does SHP then choose which SMA manager to recommend if a client has that type of request?

Cam Iarrobino: Yeah. So, it’s definitely a bit of a different process than when we are, say, looking for just a mutual fund or an TF to replace or even to add into our core investment models, aggressive and conservative, everything in between. So, there’s definitely a big quantitative piece. So, right off the bat, we’d like to know what minimums are for certain managers, the fee that they charge. But there’s a huge qualitative piece as well. We want to know how long have they been doing it in the space? What, if any, proprietary technologies do they have? What is their product line look like? Are they just offering one or two products in the space? Or do they have a bit more in terms of, yeah, again, just different product?

So, what we really try to do is find, say, maybe three to five managers in a given space. It’s intense, it’s a diligent meeting process. We meet with all of them. We vet them. Again, we just kind of assess them from both a qualitative and a quantitative perspective. And obviously, just narrow it down to a couple finalists and just discuss it a lot internally.

Matthew Peck: Okay. And I would want to say, too, because you talked about direct indexing, but I also want to make sure we speak on probably, I’d say, my personal favorite when it comes to the SMA space and where I think the most benefit comes from, and that’s in municipal bonds, because we talked about the customization, right? And so, very often, in the ETF and the mutual fund space, yes, there are municipal bond funds, but they’re kind of lower volume and there’s not a lot out there. And let’s just say we have clients that are here in Massachusetts and the idea of having as most tax efficient and I also do want to come back to the taxes because I certainly know that’s efficiency there. Not just in the muni space, but in the overall SMA space. But the Massachusetts munis, and I think that’s an area where these active managers and these SMA managers can really provide alpha, that they can really provide extra help, extra tax efficiency, extra customization. So, I think, in my opinion, that’s my favorite, but Cam, if you don’t mind, walk our clients or our listeners through what the municipal bond, SMA, and what sort of benefits are there.

Cam Iarrobino: Yeah. So, like Matt said, we have a lot of conviction and we started to develop a lot of conviction in the SMA product in the municipal bond space. We are currently utilizing AllianceBernstein in that space. Again, back this past fall and winter, we vetted quite a few different folks and landed on AllianceBernstein. So, they offer a few products, SMA products in the municipal bond space that can go down to $125,000 minimum, which we found to be pretty attractive.

And what we also found is that the fees that they’re charging are extremely competitive to the point where, and in fact, to take a step back, that wasn’t even really specific to AllianceBernstein. That was pretty much all of the managers that we looked at in that space. What we realized was most of these folks are charging a fee that, again, is significantly less than most of the products that we had been using in that space. Again, the mutual funds and even the ETFs too that we had been using in our in-house municipal bond model, which again, just consisted of mutual funds and ETFs. And it definitely has its place. Again, the $125,000 minimum, that’s very competitive we felt within the industry on the AllianceBernstein products or on some of them at least. So, I mean, that really is kind of a cutoff point. And one of the biggest benefits, obviously, is that they go in and they buy individual bonds, municipal bonds, and even in one product, potentially, they have the ability to actually buy treasuries as well, but that’s neither here nor there.

But they go in and they buy individual bonds and they just essentially actively manage that for the client instead of doing it on the fund level. So, it’s a big benefit for clients in a couple of respects. Number one, we have more ability to customize, again, on the duration level, which is really just, if you want to own, say, three-year bonds, bonds that have a maturity coming within three years, or say, more in like the 6 to 10-year space is kind of more the intermediate. That usually is the default option on most products, and then even more long term as well, which carries. I mean that, all kind of duration buckets, they all carry different risks on the short term, it’s more reinvestment risk. Not to get too technical on the long term, it’s more duration, price, fluctuation risk.

And then in the middle, it’s kind of a healthy balance of both, but we have the ability to, on any of their products, tell them that we want that given SMA, but we want it in like a short duration or we want it in a long duration. And like I said, the default is usually the intermediate one. So, we have a lot of ability to customize that also in the credit quality as well. So, credit quality is obviously a big piece of investing in bonds. The assumption that is made is that, I mean, well, a bond is a contractual obligation, so whoever issues it is required, basically, by law to pay it back. Obviously, companies can go bankrupt. Municipal issuers can run into serious rating and liquidity problems. Governments can even go, I don’t know what the technical term is, bankrupt or default.

Matthew Peck: They can default on their loans, yeah.

Cam Iarrobino: So, credit quality is a big piece. Obviously, the yields are higher on lower rated bonds because they come with more risks. And you’re not as assured that you’re going to actually realize that yield. If they pay everything back, then you will realize that yield or at least close to it. But yeah, so we have the ability to even customize the average credit quality rating of the portfolio. So, their default is generally to be usually more 60% to 70% in the high-quality space. So, those are like single A or even in some cases, double A rated and above issuers. So, very credit worthy towns and municipalities and cities, things like that, whether it’s like a general obligation or a specific revenue bond. But they do also dip into the high yield space, the higher yielding, lower rated municipal markets as well depending on just their in-house research and their research analysts and credit analysts and economists if they think that it’s a more advantageous time to be in higher yield and take on that additional risk.

But we have the ability to customize that. Within any of their products, we can tell them that we don’t want any high yield at all or we want to cap it at, say, 10% or 20% of the account, of the portfolio. So, we have a lot of flexibility there on a number of different levels. And one of the other major benefits as well is the tax alpha as we like to call it or really just tax benefits. So, obviously, anybody that is investing or thinking of investing in the municipal bond space, it’s going to be done in a taxable account. You would never buy municipal bonds and then qualified in a retirement account.

Matthew Peck: Yeah, because I want you to sort of explain a little bit about after-tax yield, right? Because we know that the SMAs are not for everyone because obviously, there are minimums like we were talking about, and not everyone has 250 grand just lying around, right? But also, it’s really targeted, specifically on the muni space towards higher income earners, right? Folks that are in the 20, 25, 30, whatever the tax bracket is, or marginally at least, the higher it is, the higher your tax bracket, the more and more desirable these munis are because of something called after-tax yield. So, if you don’t mind sort of explaining a little bit about that concept.

Cam Iarrobino: Yeah. So, speaking generally, interest received from municipal bonds is tax exempt on the federal level. It could even be potentially tax exempt on the state level as well for some states including Massachusetts. If you’re in Massachusetts and you buy a bond issued by a Massachusetts municipality, the interest received would be exempt from not only federal, but also state income tax.

So, what Matt was talking about with “after-tax yield,” let’s just take a basic example. Let’s say you can buy a CD from a bank or a federal bond issued by the federal government, also known as treasuries, treasury bonds. And let’s say, just for the sake of simplicity, again, both of those, the CD and the treasury bond at the moment, you can get a 4% yield, yield to maturity. So, you buy those, you receive 4% interest roughly on whatever you put in. Now, that interest is going to be taxable. So, you’re going to have to pay federal income tax on that.

If somebody is in a 22% federal bracket, then in essence, they’re only going to actually keep 78% of the interest that they receive because it’s going to be subject to a 22% income tax if that’s where their top dollars are getting taxed at. So, for the sake of simplicity, just a calculator on me, but let’s just say that the 22% tax, let’s just call it 25% just for the sake of simplicity because that’s one quarter. So, in essence, you’re losing a quarter of the interest that you receive to tax. So that would basically make the after-tax yield roughly around 3% because a quarter of 4% would be 1%. So, effectively, after you pay taxes, really is more like 3%.

Now, let’s say that you can get maybe 3.5% or 3.75% or even 4% right now on similarly rated or even maybe if you wanted to take a little bit more risk, maybe even higher on lower rated bonds, but let’s just say for the sake of simplicity, similarly rated municipal bond, you can get say again, 4%, that is not going to be taxed, at least on the federal level, potentially on the state level, but again, for the sake of simplicity, most of that 4% yield would truly be very close to 4% on an after-tax basis.

Matthew Peck: Which is great. And I think that’s why, as you were saying too, we’re talking about after-tax accounts, specifically in this muni SMA and higher income earners, right? That’s sort of like when it comes to “ideal candidates.” But it’s just something to really, seriously consider because the other point that we mentioned is the fact that the mutual funds that are in these municipal bond spaces are charging more than the SMA. So, it’s like, hey, this is something that we really want to take a look at after the due diligence process, that Cam was talking about earlier.

And the other thing I want to point out too, which I really enjoy about the sort of call it managed bond funds or whatever that may be and bond ladders and whatever that is, is the fact that with bonds, I mean, there is credit risk, like Cam was talking about, but if I set aside credit risk for a second, as long as you hold that bond to maturity, you get your money back, right? Like, there isn’t that guarantee with stocks, where it’s like, okay, well if I hold on the stock in five years, it’ll be up. Now, historically speaking, most stocks are, but there’s no guarantee, whereas with municipals and treasuries and different things in that space, assuming again, there’s no credit risk or default, you hold on that money to maturity, you get your money back, right?

And sort of like the ideal sort of a conservative investing in a certain extent, and so, it’s like, oh gosh, if we can have this customization, if I can have these more Massachusetts bonds for our Massachusetts clients or more main bonds for our main clients or whatever that may be, get that double taxation sort of tax free, right, potentially, obviously, on the federal as well as on the state level. And I could do it for less expensive? Then, okay, tell me about this SMA world, right? What type of investments are there? And so, whether it’s the muni, SMA, whether it’s the direct indexing, these are just examples of sort of creative investment plans, creative wrappers that we can then after a very rigorous due diligence process, of course, but after that, we can start to then kind of have more tools at our disposal.

Now, hopefully, you have an advisor right now that’s doing that already. Great. But if not, certainly reach out because I think the idea of getting that fiduciary based, because it’s like, the other interesting part too, Cam, is that it’s not like SHP makes any more or less from these SMAs, right? So, it’s like, our fee is the same whether you do an SMA or you don’t do an SMA. But I love the idea of having these tools, having these tools in the toolbox to be able to show clients and say, ooh, okay, you might be a good candidate for this or you might be a good candidate for that. Whether it’s direct indexing, whether it’s the muni space, are there any other like sort of SMA areas of interest to you, Cam, or something like, I might look into here, kind of almost like the future of SMAs?

Cam Iarrobino: Yeah, well, if I had to pick one that I think is the future, I would say probably the direct indexing on a number of levels. And again, when we say it’s the future, nobody’s going to put every single dollar that they have into it. But some of the technologies that are available there and the ability to customize things for people to people’s liking and also, the tax benefits as well. We didn’t even get a chance to touch on that of the direct indexing space. That’s definitely a big area of interest. It’s one that we’re actually, actively vetting right now, as you know, Matt. And that’s probably the biggest one that I would pick.

Matthew Peck: So, that’s great, Cam. I mean, for all the listeners out there, thank you for bearing with me during allergy season. There’s going to be a lot of coughs. And Evan, our producer, is going to be busy at work trying to sort of dust off my raspy voice right now. But all that being said, so SMA, so here we go ladies and gentlemen. We have the ability to this wrapper, right, which is, there’s a mutual fund wrapper, there’s ETF wrappers, there’s obviously individual stock, and then you have separately managed accounts, which are individual stocks or individual bonds, but they’re separately managed, right? They’re managed by third parties that are, obviously, this is all they do, right?

But after a heavily scrutinized process, now you can start to explore the potential fee benefits or less costs to the end investor. You get more customization, whether it’s in the municipal bond space or the direct indexing, like Cam was talking about. You also get tax efficiency, whether it is the after-tax yield in the bond or the municipal bond space, or some of the tax-loss harvesting that happens in the equity space and even on direct indexing, people use that direct indexing if they have a heavily concentrated position. So, let’s say, all of their stock is in Amazon and they say, ooh, I might want to de-risk this, but I have a large cost basis. How do I do this? The tax efficient tools, indirect indexing, and other SMAs allow for clients to unwind it in the most tax efficient manner, right?

So, again, fee structure, tax efficiency, customization, I mean, these are all reasons why at SHP, we said, you know what? We have to be comfortable in the SMA space. We have to do a podcast on it. And again, Cam, thanks so much for walking all of our listeners through it so that people know of the tools and the options that are available because at the end of the day, obviously, it’s the client’s decision, but our role is to advise and our role is to make sure that we are looking under every nook and cranny and coming up with the best possible and the fully vetted options for our clients.

If you feel you’re not getting that advice elsewhere, please give us a holler. We’re always here. If you are getting that advice, great. If you’re doing it yourself, I’m not sure if you have access to these types of strategies. So, again, worth a call or worth them to look into. But all in all, thank you so much for listening, Cam. Thanks again.

Cam Iarrobino: Thank you, guys.

Matthew Peck: For joining us and sharing your history too, and with the CFA as well.

Cam Iarrobino: Which it can get taken away, by the way. Ethics violations. Best behavior, yeah.

Matthew Peck: Perfect, all right. Thanks again for listening. Thanks for lending us your ears, and we’ll see you soon.

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