From SMAs to ETFs: Why a 351 Exchange Is the Ultimate Money Manager Move

February 10, 2025 EST

Investors love a roaring bull market, but after 15 years of soaring stocks, a surprising challenge has emerged:
your client’s portfolios might be weighed down by a mountain of unrealized capital gains.

Rebalancing without triggering a massive tax bill? That’s the catch. This conundrum may hit especially hard for tech workers, whose booming stock options now dominate their net worth, and long-term investors sitting on decades-old winners.

Here’s the Kicker: Your Financial Success May Have Turned into a Gilded Cage

Those impressive unrealized gains, while dazzling on paper, can lock you into positions that no longer align with your goals or risk tolerance. It’s the golden handcuffs of the investment world—your portfolio’s past glory might be keeping you from a more balanced, future-ready strategy.

Fortunately, there may be a way to break free. Whether you’re looking to reduce risk or reallocate your portfolio without triggering hefty capital gains taxes, one smart strategy could hold the key: converting to an ETF via a 351 exchange.

In the ever-evolving world of wealth management, money managers and family offices constantly seek strategies that improve efficiency, reduce tax liabilities, and align with clients' financial goals. For those managing separately managed accounts (SMAs), converting these accounts into Exchange-Traded Funds (ETFs) through a Section 351 exchange presents a compelling opportunity. This approach can streamline operations, enhance tax efficiency, and offer diversified investment solutions tailored to clients’ needs.

Here’s why money managers and family offices should consider leveraging a 351 exchange to convert SMAs into ETFs.

What Is a 351 Exchange?

A 351 exchange refers to Section 351 of the Internal Revenue Code, allowing individuals or entities to transfer appreciated assets into a corporation in exchange for stock without triggering immediate capital gains tax. In the context of SMAs, this strategy enables money managers to transition clients’ assets into an ETF structure while deferring the tax consequences typically associated with selling the underlying securities.

Key Benefits of Converting SMAs to ETFs via a 351 Exchange

Tax Deferral on Appreciated Assets
Many SMAs hold highly appreciated securities, and selling them to transition into a new investment structure can trigger significant capital gains taxes. A 351 exchange allows these assets to be transferred into an ETF tax-free at the time of exchange, preserving the full value of the investment for compounding growth. This is a particularly attractive feature for high-net-worth individuals and families seeking to maximize wealth retention.
Improved Tax Efficiency
ETFs are renowned for their tax-efficient structure, primarily due to their in-kind creation and redemption processes. This minimizes taxable events, unlike SMAs, where buying and selling securities can generate annual tax liabilities. Converting SMAs into ETFs can reduce the ongoing tax burden for clients, enhancing after-tax returns.
Streamlined Operations
Managing multiple SMAs with individualized investment strategies can be labor-intensive and costly. Converting these accounts into an ETF consolidates assets into a single, scalable investment vehicle. This reduces administrative complexity, simplifies reporting, and allows money managers to focus on optimizing the ETF’s performance and strategy.
Customizable Investment Solutions
ETFs are highly flexible and can be designed to meet specific investment objectives, such as focusing on particular sectors, geographies, or ESG criteria. By converting SMAs into a customized ETF, family offices can maintain alignment with the unique goals and preferences of their clients while benefiting from the efficiencies of an ETF structure.
Enhanced Marketability and Access
An ETF provides liquidity, transparency, and accessibility that individual SMAs often lack. Once created, ETFs are typically exchange listed, making it available to a broader range of investors. This increased marketability can enhance a money manager's reputation and attract additional assets under management (AUM).

How to Execute the Transition

Formation of the ETF: The process begins with letting ETC create your own custom ETF. Either in-house or through third party service providers, ETC provides all the necessary service providers, lawyers and auditors necessary to effect your 351 conversion.
Asset Transfer: Using a 351 exchange, the securities from SMAs are transferred into the ETF in exchange for shares of the ETF, deferring any tax liabilities on the appreciated assets.
Client Transition: Clients now hold shares of the ETF, rather than individual securities in their SMA account. This allows them to maintain their exposure to desired investment strategies within a more efficient structure.

Final Thoughts

For money managers and family offices, converting SMAs to ETFs via a 351 exchange represents a forward-thinking strategy that seeks to deliver tax efficiency, operational simplicity, and enhanced investment opportunities. By taking advantage of this approach, firms can better serve their clients, increase scalability, and position themselves as innovators in wealth management. Consulting with legal, tax, and financial experts is essential to navigate the complexities and ensure a successful transition.