Newest Addition to Dimensional SMAs: ETFs

Dimensional separately managed accounts (SMAs), informed by the firm’s decades of research and experience, go beyond direct indexing to systematically target higher expected returns while balancing the tradeoffs among premiums, costs, diversification, and taxes every day. Investors can customize a Dimensional SMA for environmental, social, and governance (ESG) preferences, tax goals, and individual stock, sector, and country holdings. Dimensional SMAs also seek to deliver operational efficiencies for financial professionals by providing a streamlined process to launch, manage, and monitor accounts, empowered by an intuitive online platform and a dedicated SMA Solutions team.

Now, we are pleased to announce that Dimensional has added the ability to include exchange-traded funds (ETFs) along with direct security holdings. How can the integration of ETFs and direct security holdings within an SMA potentially benefit investors and their advisors?

• Holistic tax management¹ across the overall portfolio
• Greater flexibility for asset class exposure
• Enhanced operational efficiency

Dimensional’s multifaceted approach to tax management applies across both ETFs and direct securities held in a Dimensional SMA, providing for a holistic assessment of opportunities to improve the after-tax performance in a client’s overall portfolio.

Dimensional SMAs pursue higher expected returns while minimizing tax costs. Our approach to tax management considers capital gains, capital losses, and dividend income at every step of the investment process, from portfolio design to portfolio execution. When an investor chooses to hold ETFs in addition to direct securities within a Dimensional SMA, we are able to apply our multifaceted approach to tax management across the entire account.

The broad diversification of our strategies provides ample opportunities to replace a security sold at a loss with another that has a high expected return without violating the wash-sale rule.² Similarly, for ETFs, we can use an alternate fund, chosen by the advisor, to replace an ETF sold at a loss in order to maintain an investor’s desired asset class exposure.

We monitor ETF positions for meaningful opportunities to harvest losses and evaluate each opportunity against its expected impact on the targeted asset allocation while taking into account the tax management approach selected by the advisor. For example, if an advisor selects Aggressive tax management for a client’s SMA, we will allow ETF allocations to drift further from target weights in order to harvest losses and limit realized gains.

By integrating ETFs with direct equities, we can more efficiently rebalance an investor’s portfolio. Cash generated from harvesting losses in ETF positions can be allocated to direct security holdings, which broadens the opportunity set for future loss harvesting by establishing new cost bases in multiple individual stock positions.

We believe our daily approach to tax management provides more opportunities to harvest losses and rebalance efficiently than approaches of peers that may limit trading to less frequent intervals, such as once a month. By applying our daily process to both direct equities and ETFs, Dimensional SMAs can extend those benefits to a larger part of an investor’s portfolio.

Finally, by putting stocks and ETFs into one account, advisors enable Dimensional’s Portfolio Managers to evaluate a broader set of securities when addressing specific client requests, such as redemptions, gain harvesting, and charitable giving, and to provide advisors and their clients with more tax-efficient solutions.

Integrating ETFs and direct security holdings in a Dimensional SMA can provide greater flexibility for asset class exposure.

When designing a Dimensional SMA for a client, an advisor can use direct security holdings or a combination of direct security holdings and ETFs to tailor the asset class exposure to the client’s unique needs. A combined approach may be preferred for multiple reasons. For instance, an investor may choose to hold ETFs within a Dimensional SMA to get exposure to asset classes not available via Dimensional SMA direct security strategies, such as REITs or fixed income.

Another reason could be to alter the way in which exposure to a market or region is achieved. Due to the operational challenges and high costs of direct exposure to stocks trading on foreign exchanges, Dimensional SMAs provide exposure to international large cap stocks via American depositary receipts (ADRs). Investors who want exposure to both large and small cap international stocks can instead achieve that by adding Dimensional international equity ETFs to a US-focused strategy with direct equity holdings.

Finally, advisors can use ETFs within a Dimensional SMA as an additional lever with which to customize the relative weights of regions within equities or the level of emphasis on the long-term drivers of stock returns—size, value, and profitability. For instance, an investor may prefer overweighting exposure to US equities relative to ex-US equities. To obtain the desired exposure, an advisor can build an SMA composed of US direct equity holdings and Dimensional international and emerging markets equity ETFs with target weights that emphasize the US direct equity component.

A single-account solution can reduce costs for both investors and their advisors and enable more integrated portfolio management.

For an investor who prefers to hold ETFs in addition to direct securities, consolidating holdings into one account can reduce or eliminate costs associated with maintaining multiple custody accounts. Investors may also benefit from more efficient and consistent portfolio rebalancing. Every day, Dimensional’s Portfolio Managers review opportunities to rebalance across ETF and direct security holdings in a Dimensional SMA to maintain a desired component mix. Portfolio Managers can also use cash flows from dividends, corporate actions, or the sale of securities in one part of a Dimensional SMA to rebalance an investor’s overall portfolio toward its desired characteristics.

For the advisor, Dimensional SMAs represent a single-account solution that can save time and lower costs. Dimensional monitors client ETF positions at the tax-lot level to capture tax loss harvesting opportunities and avoid wash sales, simplifying account monitoring for advisors. Advisors can also save time and lower operational costs related to ETF trades since Dimensional trades both ETFs and direct securities in the SMA account.

Moreover, by holding ETFs and direct securities together, Dimensional SMAs can help advisors streamline their process of monitoring the performance of a client’s overall portfolio and simplify account reporting for client conversations. This can free up advisors to provide additional client services and grow their business.

This enhancement to Dimensional’s SMA offering also allows an investor to fund a new SMA with legacy ETF holdings, providing greater flexibility and a more streamlined launch process for advisors and their clients. When legacy ETF holdings are used to fund an SMA, Dimensional’s Portfolio Managers are able to apply our multifaceted tax management process to efficiently transition these existing holdings to the client’s target asset allocation.

Dimensional SMAs offer our systematic investment approach—built on more than four decades of experience applying financial science to investment solutions—in a highly customizable format that enables advisors to design strategies to better fit the financial goals, preferences, and values of their clients. Dimensional SMAs also provide integrated management of ETFs and direct security holdings within a single account to offer an additional level of customization for advisors and their clients. To learn more, financial professionals can contact a Dimensional representative or visit the SMA Collection on MyDimensional.com.