The hidden pitfalls of managed accounts: What investors need to watch for

Managed accounts promise professional oversight, tailored strategies, and diversification. Sounds great, right?

But here’s the catch—hidden risks lurk beneath the surface. These aren’t the obvious dangers like bad stock picks or market downturns. We’re talking about the sneaky, hard-to-see issues that quietly erode your returns and misalign your interests.

So, what exactly should you watch out for?

Let’s break it down.

1. Closet indexing: Paying for active management, getting passive results

You’re paying for an “active” manager, expecting market-beating returns… but what if your portfolio is just a fancy (and expensive) index fund in disguise?

Closet indexing happens when managers claim to be active but stick so closely to a benchmark that you’re essentially paying premium fees for passive-like results.

🔎 How to spot it:

• High correlation to benchmarks – If your portfolio moves almost identically to the index, that’s a red flag.

• Low active share (<60%) – A key metric showing how different a portfolio is from its benchmark. Learn more at:
  https://www.morningstar.com/funds/how-use-active-share-evaluate-etfs

• Minimal tracking error – A very low divergence from the index suggests it’s just mirroring the market.

⚠️ Why it’s a problem:
Closet indexers fail to justify their fees. Research from the Financial Conduct Authority (FCA) found that many "active" funds do not significantly outperform index funds after fees.

2. Fee traps: Layered costs that erode returns

Think you’re only paying a management fee? Think again. Managed accounts often come with a web of hidden costs that quietly eat into your returns.

💰 The hidden fee culprits:

• Management fees – A percentage of assets under management (AUM).

• Performance fees – Extra costs if the fund beats a benchmark (sometimes structured unfairly).

• Trading costs – Commissions, bid-ask spreads, and market impact fees.

• Platform fees – Additional costs for using third-party platforms.

🔎 How to spot it:

• Scrutinize the fee disclosure section in your investment documents.

• Compare expense ratios with similar funds.

• Ask about hidden costs like transaction fees and soft-dollar arrangements.

⚠️ Why it’s a problem:
Even a small fee difference compounds over time. Research by the SEC shows that a 1% fee difference can cost hundreds of thousands in lost returns over decades. Learn more at:
https://www.sec.gov/files/ib_mutualfundfees.pdf

3. Hidden exposures: Unintended risks in your portfolio

Your managed account may claim to be diversified, but what if you’re unknowingly overexposed to risky sectors, leverage, or style drift?

🤯 Common hidden risks:

• Overconcentration – A few stocks, sectors, or regions dominating your portfolio.

• Leverage & derivatives – Borrowed money or complex instruments amplifying risk.

• Style drift – A fund labeled “value” suddenly loading up on high-growth tech stocks.

🔎 How to spot it:

• Look beyond the top holdings—check sector concentrations.

• Examine exposure reports and stress tests for hidden risks.

• Make sure the investment style matches the strategy you signed up for.

⚠️ Why it’s a problem:
Unintended risks lead to unexpected volatility and poor risk-adjusted performance. The CFA Institute warns that poorly managed risk exposure can significantly impact long-term results.

4. Veiled underperformance: The illusion of strong returns

Your manager shows you impressive returns—but are they real? Or just cleverly presented?

🚩 Common tricks that mask underperformance:

• Cherry-picked timeframes – Short periods of outperformance that ignore the full market cycle.

• Improper benchmarks – Using an easier-to-beat index instead of a relevant one.

• Survivorship bias – Poorly performing funds quietly closed or merged, making the average returns look better.

🔎 How to spot it:

• Look at rolling returns over multiple market environments.

• Use risk-adjusted metrics like the Sharpe ratio or alpha to see if returns justify the risks. Learn more at:
  https://www.investopedia.com/terms/s/sharperatio.asp

• Ensure the benchmark is appropriate for the strategy.

⚠️ Why it’s a problem:
Many investors chase shiny short-term performance without realizing it’s unsustainable. Research by SPIVA shows that most active managers underperform their benchmarks over time. See the report at:
https://www.spglobal.com/spdji/en/spiva/article/spiva-us/

5. Invisible alignment breaks: When managers’ interests don’t match yours

Your investment manager should have your best interests at heart. But sometimes, their incentives tell a different story.

🤔 Where misalignment creeps in:

• AUM-driven incentives – More assets = more fees, so managers prioritize growth over performance.

• Short-term focus – Managers may trade aggressively to show quick wins, harming long-term returns.

• Product proliferation – Firms launching new funds just to rake in more fees.

🔎 How to spot it:

• Watch for excessive fund launches with similar mandates.

• Check manager compensation—long-term incentives are better for investors.

• Look for manager co-investment—if they invest in their own strategies, they have skin in the game.

Implementing a financial control system to safeguard your investments

To avoid these pitfalls, platforms like Truthifi recommend a 5-step financial control system:

1️⃣ Consolidate all your financial data – Gather bank statements, investment summaries, tax returns, and other essential documents in one place.
2️⃣ Structure your finances around goals – Define short-, mid-, and long-term financial objectives and align your portfolio accordingly.
3️⃣ Understand what you own and why – Ensure each asset serves a purpose, fits your risk profile, and justifies its fees.
4️⃣ Monitor fees and risks regularly – Conduct periodic reviews to identify hidden costs, overconcentration, and unnecessary risks.
5️⃣ Optimize your strategy over time – Adjust allocations, rebalance your portfolio, and minimize tax inefficiencies as your financial situation evolves.

Learn more about this process at:
https://www.truthifi.com/education/how-to-manage-your-wealth

Final thoughts: How to protect yourself

Managed accounts can be valuable—but only if you stay vigilant. Before committing, take these steps:

✅ Compare fees carefully
✅ Assess true active management
✅ Monitor risk exposures
✅ Evaluate long-term results
✅ Check for alignment
✅ Implement a financial control system

By watching for these hidden pitfalls and using a financial control system, you can protect your wealth and make smarter investment decisions. After all, your money should be working for you—not just your fund manager.