A different approach to managed accounts
The HFR Group was founded in the early 1990s by Joseph G. Nicholas, who developed the managed account concept to resolve a structural problem that left hedge fund investors at risk from fraud and manager blow-ups. He also sought to fill the complete void of information about the hedge fund industry by establishing our sister company Hedge Fund Research, which today maintains one of the largest commercial databases of hedge fund information.
Since the early 1990s, the industry has grown exponentially and thousands of funds of hedge funds have been established. However, the initial problems persist and fund of hedge funds managers still struggle to build efficient portfolios through investments in flagship funds based on mostly incomplete and out of date information.
The tremendous growth in assets ended abruptly last year amid outflows that saw many single-manager hedge funds suspend redemptions, impose gates or create side-pockets. As a result, the hedge fund industry has recognised the need for transparency and other safeguards in order to make better decisions.
In short, the rest of the industry is now slowly moving to a model that HFR Asset Management has endorsed and operated for years. HFR utilises managed accounts within a trust structure, with an appointed trustee acting on behalf of unitholders. The trustee is independent of HFR, as is the custodian and the administrator – vital for a closed system.
Each hedge fund manager typically trades the HFR managed account pari passu to its flagship fund, but has no legal rights to the trust’s assets. The manager’s sole responsibility is to trade the fund’s account, while having no control of or access to its assets. For a managed account structure, complete segregation of all roles is vital, and HFR ensures that all those roles are functioning properly.
Each day HFR downloads all positions in the managed accounts directly from the prime brokers. It also obtains trade blotters from the managers daily and position files weekly. The firm’s risk team reconciles the positions for each manager, independently prices every security, and investigates any discrepancy between HFR’s valuation and the broker valuation. HFR independently prices each portfolio daily on a T+1 basis, and then reconciles the prices each week and at the end of each month with the administrator, which produces the official valuations.
A dedicated risk team ensures that each manager remains in compliance with its pre-established investment guidelines, which are tailored to each manager’s particular strategy, liquidity profile, sector exposure and instruments. Any breaches are assessed according to three levels of severity.
The risk team also maps every position of each manager within RiskMetrics and runs some 214 different stress tests for each portfolio based on position-level information, enabling HFR to understand and inform investors daily of the distribution of risk within each account. This is the basic tenet of portfolio management theory – understand the risk of what’s going into your book, and construct the portfolio based on that risk.
Independence also distinguishes HFR from other platform providers. Not being part of a banking group avoids certain conflicts of interest that could otherwise arise. The level of information we deliver to our clients is more comprehensive than that provided by other platforms. Finally, HFR is not a newcomer to the business in response to the recent market turmoil, but has been developing and honing managed account structures and processes since the early 1990s.
Marc E. Denogent is a managing director with HFR Asset Management
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