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Investing Perspective published on November 22, 2022

Separate Accounts Align With Our Client-Centric Values

Breckinridge delivers investment solutions through separate accounts because this approach aligns with the first of our Core Values: We put clients first.

For every client—individual or institutional—two valued qualities in an investment service relationship are transparency and customization. We believe that separate accounts allow us to deliver these two essential qualities more effectively than commingled funds, including mutual funds.

Tenets of the mutual fund approach

Over decades, asset managers migrated to investment solutions that are based on a one-to-many model; funds that commingle investments from many investors and pursue broad objectives. Investors own shares of the company—that is the fund—whose business purpose is to buy securities issued by other companies. Thus, fund shareholders do not directly own the securities held by the fund portfolio. Rather they share in the profit and losses of the fund’s total holdings. This approach may be appropriate in certain asset classes based on desired characteristics related to quality, diversification or liquidity.

For investment grade fixed income, quality, diversity and liquidity all can be found in a single portfolio of individual bonds. However, we believe an investment grade bond fund that commingles many investors’ assets and seeks to achieve broad objectives—as mutual funds do—may find it difficult to the meet disparate needs of many individual shareholders. Breckinridge manages separate accounts because we believe they can better address the goals of each individual investor more effectively than a mutual fund.

Separate accounts are different

Separate accounts allow us to deliver one-to-one client-centric solutions that are customized and transparent.

  • Transparency. In a separate account, there are no distractions caused by fund flows associated with other investors. The value of shares may be diluted as new shares of the fund are created for new investors. As other investors redeem shares and leave the fund, the share value of remaining shareholders may also be diluted.1 For the shareholders, the effect of daily fund flows on the net asset value (NAV) of the fund can be opaque.

    In a separate account, the holdings are owned by the investor. There are no shared interests. Contributions and withdrawals from the account are made at the discretion of the owner. Investment decisions made by the portfolio manager are executed in accordance with the owner’s Investment Policy Statement.

  • Customization. Each client’s goals are personal and unique: investment horizons, return objectives, volatility and risk tolerances, tax circumstances and other individual characteristics. A separate account and every security in its portfolio are owned directly by the client; thereby giving the client flexibility to customize the investment parameters to their own personal and unique goals.

    Creating a separate account starts with understanding the client’s goals and tailoring an investment strategy—constructing and managing a portfolio—intended to reach the goals. The fact that the client is the direct owner of every security in the portfolio is consistent with that approach.

Separate accounts are well-suited to bond investors

Breckinridge was founded more than 30 years ago to manage investment grade fixed income portfolios. We believe separate accounts are particularly appropriate for investors in this asset class.

An important role of bonds in a portfolio of investments is to mitigate or balance risks while achieving capital preservation and consistent income, particularly during times of distress in other sectors of the investment markets. A separate account allows that role to remain the key focus of every bond added to or sold from the portfolio.

For instance, a mutual fund may find it necessary to sell bonds during times of market stress to meet redemptions requested by shareholders; bonds that might otherwise continue to be held in a less volatile investment environment. The separate account investor may choose to sell bonds in order to meet liquidity or other needs, but always retains the option of holding bonds until maturity.

Let’s look at this concept more closely.

Buy decisions: Separate account strategy decisions are not compromised by the need to buy bonds simply because fund flows from other shareholders force purchases and the governing documents of the mutual fund limit the percentage of the portfolio that can be held in cash. In those instances, funds may be compelled to add bonds it might not otherwise hold due to reasons related to bond quality or sector preferences, for example. While separate account investors may seek to keep cash held in the account to a minimum, preferring to hold high quality, longer-term bonds instead, the option remains to maintain cash until opportunities for more appropriate investments are available.

It is also worth noting the dilution effect that new shareholders can have on income earned by a mutual fund. The tax ramifications of this concept are considered in more detail later in this article, but for now, suffice to note briefly that as a mutual fund adds new shareholders, in certain instances the benefit of income it earned prior to issuance of new shares can be realized by more shareholders and thus, diluted for the longer-tenured shareholders.

Sell decisions: Further, sell decisions in a mutual fund, can be forced by the need to meet redemptions paid to other shareholders. Mutual fund shareholders are vulnerable to the behavioral patterns of other retail investors, and historical tendencies among them to sometimes ‘buy high, and sell low,’ particularly during times of market uncertainty. During periods of dislocation, bond funds facing redemptions may cause their managers to sell bonds into a distressed market at distressed prices. The trend can exacerbate negative performance during periods of interest rate volatility.

On the other hand, separate account owners and their portfolio managers retain a relatively higher level of control over their specific sell decisions; this can prove especially helpful when raising cash. Mutual fund shareowners faced with the need to raise cash must sell their shares in the fund; in effect, selling their proportional ownership share of the fund. Separate account owners and their portfolio managers can be more discerning in their decision making when raising cash as they can select from the individual securities held in the account for potential sale.

During times of market volatility, a separate account may prove to be a source of stability in uncertain times. It is our experience over the last three decades that a well-structured portfolio of bonds can help an investor cope with market dislocation by providing a return of both income and capital that can be earned independent of the market, whereas the capacity of a bond mutual fund to offer such a haven may be compromised by the purchase and redemption activity of other shareholders, as illustrated in the examples presented earlier.

Investors in fixed income separate accounts can choose to collect their interest payments and hold the bonds they own until maturity–receiving principal repayment in full and earning a predictable return prior to maturity, no matter what broader market volatility might occur.2 While mutual fund shareholders can choose to retain their shares in the fund, they may experience changes in the fund’s NAV and, thus, the value of their investment over the course of time. Even in periods of rising rates, we believe fixed income separate accounts can be a stabilizing force for investors.

For some investors, separate accounts have additional tax planning advantages

Particularly for investors managing individual tax considerations, the ability to customize a separate account can be a compelling differentiator. As the owner of the bonds in the account, the investor has a cost basis on each security, whereas a mutual fund shareholder has a cost basis based on the price at which they purchased shares of the fund. Cost basis is an important component to calculating capital gains and losses in addition to deciding when to take them. A mutual fund investor does not have an individual cost basis for the securities held in the fund nor does the fund shareowner have a voice in when capital gains are taken.

Capital gains and losses play an important role in tax planning. Harvesting them is a technique for minimize tax liability. Through the selective realization or harvesting of investment gains and losses, a separate account investor may offset gains generated by one security within the account with losses realized by another security. In this manner, an investor can exercise more control over their capital gains tax liability. In mutual funds, all investors share the tax liability on capital gains incurred by the fund, which must be paid to shareholders once a year.

For some investors, purchasing fund shares could incur a tax liability for gains in the fund even if the investor did not benefit from those gains. Since many mutual funds pay out their gains in December, purchasing fund shares late in the year can result in a tax liability for the investor on the gains already sustained by the fund during the year. Unlike mutual funds, separate account owners would be liable only for capital gains generated after they invest.

Further, tactical portfolio strategy decisions such as adding out-of-state bonds and taxable municipal bonds to the portfolio may be more easily accomplished in a separate account with a wider investment mandate, as defined by the owner’s Investment Policy Statement, than in a mutual fund which is bound to the investment parameters defined in its prospectus. Because some fund investment parameters and strategies may not be changed without shareholder and/or fund Board approval, funds may not be as nimble as separately managed accounts.

Our ability to customize portfolios also affords clients with the capacity to organically transition between strategies. For example, if an investor deems a short-term strategy a more appropriate fit for the near-term but has a desire to transition to an Intermediate strategy overtime, our portfolio management team can develop a transition plan to thoughtfully and opportunistically extend the portfolio. Conversely, a transition from a short- to intermediate-term commingled fund may often result in 100% turnover at the time of extension.

Mutual funds may be more suitable for many investors, often based on the size of the initial investment since mutual funds tend to have lower investment minimums than separate accounts. This can be an attractive entry point for some investors as they can pool their assets with other like-minded investors to create greater buying power than purchasing securities individually in an account. Speaking with an investment professional will help determine whether a separate account is a suitable investment method. Fees and expenses for the two investment vehicles vary, with some separate accounts charging less than some mutual funds and some charging more. Again, a financial advisor can help investors conduct the due diligence necessary to understand the comparative costs and value.

For our part, Breckinridge manages separate accounts because, at the highest level, they align with our vision of excellent investment management and client service.


[1] As investors enter or exit a mutual fund, the portfolio manager will purchase and sell securities. This activity incurs trading costs such as brokerage fees, transaction charges and taxes, which are charged to the fund and are borne by all existing shareholders, rather than the investor who has just traded the shares. This problem is magnified when the fund is valued each day. This is because the price at which investors buy and sell shares is based on a valuation point of the underlying securities, usually the last traded price at the end of the previous trading day. The NAV does not reflect trading costs resulting from investment subscriptions and redemptions. This is known as dilution and can negatively impact returns for existing shareholders of the fund. Some funds have adopted procedures to counter the effects of dilution during periods of large inflows or outflows. The intention is to adjust the price so that the investors who are buying or selling the shares pay their fair share of the costs.

[2] Assumes no bond issuer defaults, which are rare among investment-grade bond issuers.

This material provides general and/or educational information and should not be construed as a solicitation or offer of Breckinridge services or products or as legal, tax or investment advice. The content is current as of the time of writing or as designated within the material. All information, including the opinions and views of Breckinridge, is subject to change without notice.

Any estimates, targets, and projections are based on Breckinridge research, analysis, and assumptions. No assurances can be made that any such estimate, target or projection will be accurate; actual results may differ substantially.

Past performance is not a guarantee of future results. Breckinridge makes no assurances, warranties or representations that any strategies described herein will meet their investment objectives or incur any profits.

Any index results shown are for illustrative purposes and do not represent the performance of any specific investment. Indices are unmanaged and investors cannot directly invest in them. They do not reflect any management, custody, transaction or other expenses, and generally assume reinvestment of dividends, income and capital gains. Performance of indices may be more or less volatile than any investment strategy.

Performance results for Breckinridge’s investment strategies include the reinvestment of interest and any other earnings, but do not reflect any brokerage or trading costs a client would have paid. Results may not reflect the impact that any material market or economic factors would have had on the accounts during the time period. Due to differences in client restrictions, objectives, cash flows, and other such factors, individual client account performance may differ substantially from the performance presented.

All investments involve risk, including loss of principal. Diversification cannot assure a profit or protect against loss. Fixed income investments have varying degrees of credit risk, interest rate risk, default risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer-term securities. Income from municipal bonds can be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the IRS or state tax authorities, or noncompliant conduct of a bond issuer.

Breckinridge believes that the assessment of ESG risks, including those associated with climate change, can improve overall risk analysis. When integrating ESG analysis with traditional financial analysis, Breckinridge’s investment team will consider ESG factors but may conclude that other attributes outweigh the ESG considerations when making investment decisions.

There is no guarantee that integrating ESG analysis will improve risk-adjusted returns, lower portfolio volatility over any specific time period, or outperform the broader market or other strategies that do not utilize ESG analysis when selecting investments. The consideration of ESG factors may limit investment opportunities available to a portfolio. In addition, ESG data often lacks standardization, consistency and transparency and for certain companies such data may not be available, complete or accurate.

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Net Zero alignment and classifications are defined by Breckinridge and are subjective in nature. Although our classification methodology is informed by the Net Zero Investment Framework Implementation Guide as outlined by the Institutional Investors Group on Climate Change, it may not align with the methodology or definition used by other companies or advisors. Breckinridge is a member of the Partnership for Carbon Accounting Financials and uses the financed emissions methodology to track, monitor and allocate emissions. These differences should be considered when comparing Net Zero application and strategies.

Targets and goals for Net Zero can change over time and could differ from individual client portfolios. Breckinridge will continue to invest in companies with exposure to fossil fuels; however, we may adjust our exposure to these types of investments based on net zero alignment and classifications over time.

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The effectiveness of any tax management strategy is largely dependent on each client’s entire tax and investment profile, including investments made outside of Breckinridge’s advisory services. As such, there is a risk that the strategy used to reduce the tax liability of the client is not the most effective for every client. Breckinridge is not a tax advisor and does not provide personal tax advice. Investors should consult with their tax professionals regarding tax strategies and associated consequences.

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