Big institutions favour SMAs as growth remains steady
By James Williams - As the number of managed account platforms (MAPs) increases, seemingly in response to the growth in institutional investors entering the realm of hedge funds, one might assume that managed account AUM is following a steep upward trajectory.
Platforms like AlphaMetrix have done well attracting assets, and a survey of the top ten platforms earlier this year by an industry publication showed that their combined AUM had risen from USD41.3billion in 2010 to USD52.8billion. However, the much-predicted post ’08 deluge in assets hasn’t materialised, giving way instead to steady growth in AuM.
A JP Morgan 2011 Investor Sentiment Report found that last year only 29 per cent of respondents planned to invest in separately managed accounts (SMAs), whilst in 2009 of the 40 per cent of respondents who intended to allocate, less than 20 per cent did so. There’s no doubting their growing popularity but to suggest commingled funds have suddenly fallen out of fashion would be folly.
“We haven’t necessarily seen a big ramp-up in the number of platforms that we support but we are definitely seeing increased activity across the board in those existing platforms,” confirms Oliver Scully, managing director at Citco Fund Services. Administrators like Citco, who’ve long served hedge fund managers, are seeing their client base broaden as big institutions opt for managed accounts. It’s becoming a case of servicing one investor, multiple manager mandates as well as one manager, multiple investors in the commingled world. “What you’re also now seeing is an increased desire for daily NAVs, shorter liquidity terms etc,” adds Scully.
Investing in its systems to serve managed accounts and provide a wide range of additional services to both the investment managers and underlying investors is important to custodian bank BNY Mellon because “our clients expect nothing less” says CEO of Alternative & Broker Dealer Services, Brian Ruane. “We’re making a considerable year-on-year investment in our systems’ capabilities reacting to market developments and pre-empting future changes. It’s investments such as these that keep us at the forefront of the fund servicing industry.”
The level of interest in SMAs from pension funds is apparently one of the biggest trends right now says Martin Fothergill, managing director dbalternatives Hedge Fund Platform, Deutsche Bank: “It feels like the business has changed. These are big investors, they’re a new client base. I think what’s changed is the desire of many investors to move their hedge fund investments wholesale into managed accounts.”
Caelim Parkes is a director at MSS Capital. Part of the firm’s expertise is providing advise to service providers into how they can rearrange their current operations to support SMAs. He says that asset control is an important reason for investors wanting segregated accounts. “Part of our work lately is looking at how you integrate a FoHF/hedge fund-related business into asset management businesses with a broader long-only operation. The system operating environment for hedge funds and long-only products differ substantially and it’s essential that suitable platforms are established to control data and information across differing product lines,” says Parkes.
Another reason for wanting asset control is because as institutions’ knowledge of hedge fund strategies deepens, so their willingness to move into more complex areas increases. Global macro and CTA strategies are now attracting interest with Fothergill confirming: “We’ve seen a fairly broad spread of strategies but CTAs have been the biggest theme in our business this year. Knowing how they perform in difficult markets has probably been the main driver of interest.”
Citco’s Scully adds: “Investors are getting into more complex product areas which puts greater strain on risk systems, they require different skills sets and high calibre staff in operational teams. As they get into multi-strategy, global macro funds etc there will be greater exposure to OTC instruments.”
Whether an investor chooses to join an existing MAP or go it alone depends on the size of its assets. For a USD50billion pension fund building a customised platform is realistic, for a USD1billion fund perhaps less so. With counterparty risk back on the table, partnering with best-in-class service providers is essential. Platforms such as the dbalternatives Hedge Fund Platform use multiple prime brokers and administrators and can capitalise on strong balance sheets when attracting new assets. An obvious downside to this is that public MAPs use a “one shoe fits all” approach. The investor has less control over which service providers are used but up-front costs are lower and speed to market is far quicker.
“Service providers like J.P. Morgan Securities Services or Bank of New York have the balance sheets, deep pockets and systems designed for high volume/sophisticated businesses. The current crop of public platforms such as Innocap and Deutsche have done well raising assets and use service providers best suited to their needs. Whether these providers are the ‘best’ is up to the users to determine,” says Parkes.
Deutsche’s Fothergill says that total AUM on dbalternatives is just over USD7billion. Over the past year it’s grown by USD2.5-3billion. “We’re an open-architecture platform. We work with four administrators and seven or eight prime brokers and plug them straight in providing an end-to-end service for investors. The reason investors are coming to Deutsche is because it’s a mature platform, almost 10 years old. We have a lot of experience and of course access to the best managers.”
“What we’ve seen is a lot of investors coming to the conclusion that when you look at the amount of staffing, infrastructure etc to do it in-house, it’s attractive to go to an existing platform like ours where everything is set up already. It’s a more robust solution and doesn’t require the investor to take operational risk and sometimes fiduciary risk. It’s important they have a strong counterparty.”
Fothergill further adds that bigger sophisticated managers are talking to different platform providers and assessing who has the best operational infrastructure. This is good for investors because MAPs are being kept on their toes, constantly looking for ways to improve and win market share.
BNY Mellon is actively capitalising on its triple-A credit rating to grow the business and take on more institutional managed account mandates. In Ruane’s view, ‘service’ quality is only one half of the equation: ‘financial’ quality is equally important. “Clients and their underlying investors are paying increasing attention to the financial robustness of their service providers. With our outstanding financial ratings and well-capitalised balance sheet clients know that when they contract with BNY Mellon they’re doing so with a stable organisation,” comments Ruane.
Scully says that one of the areas in which administrators are being pushed is the provision of more advanced risk capabilities. “There’s more pressure for stress testing, scenario analysis and enhanced transparency reports. Investors want to see counterparty risk analysis,” says Scully.
Coming from a long-only environment where segregated accounts are commonplace, institutions could conceivably be carrying that mindset into alternatives. “From my own experience investors like managed accounts because they want their money invested through a structure that suits them in terms of the control and transparency. Whether it’s because they’re coming from a different starting point is a very good question,” comments Tim Pearce, a partner at law firm Simmons & Simmons.
Those with significant assets and fiduciary responsibilities need to decide whether the up-front costs of creating a bespoke private platform are outweighed by the benefits of having total control and superior governance. The majority of DB Alternatives’ investors sit on the commingled public platform but Fothergill confirms “we run a number of private platforms for large investors”.
Typically, the AUM threshold to go down this road - cherry picking service providers and giving an investment manager a mandate - is USD100million.
Customisation is an area that some people like MSS Capital’s Parkes would like to see evolve. “If an institution can spend three to six months looking at different options it can build a platform without needing to pay away the likes of 80+ basis points annually by being on one of the current public platforms – 80 basis points on USD10billion over 10 years is quite a lot of return it could be giving back to its investors. Of course there are upfront costs but customisation allows an investor to build a product that fits its needs with the right service providers for the right assets.”
A Preqin survey in September 2011 found that 75 per cent of investors regarded liquidity as an important issue. It suggested this was driving growth in managed accounts. However, as a percentage of total hedge fund assets they still represent a small figure: around 3 per cent.
There are various reasons why we haven’t seen the expected explosion in AUM post ’08. For some, the operational burden isn’t worth it. For others, there’s the possibility of tracking error. Andrew Rubio, chief executive of Throgmorton the outsourced back office service provider to the asset management industry, says: “We’re not talking about tracking errors that you sometimes get in UCITS funds versus Cayman vehicles but there could be some performance drift depending on the size of the investment.” He also thinks one of the challenges facing managed accounts is the tension between investor and manager. “Some managers want to do things their own way without somebody breathing down their neck. They want investors to trust them to do their job without constantly questioning what they’re doing and why.”
Pearce picks up on the tracking error point: “In my experience if you ask managers what is the number one issue with managed accounts they spend their time dealing with they all say tracking error: minimizing it, explaining it to the client. If you’re running a USD20million managed account and a USD2billion fund you’re going to have rebalancing issues. Also, there may be certain trades a manager wants to execute that are too big for the managed account. Some managed accounts don’t use the same brokers as the manager and can’t necessarily get the same credit lines. Tracking error is an operational issue as well as in investment issue.”
Ten years ago, few hedge fund managers would have entertained the idea of taking on a managed account. That’s now changing. Managers have much greater awareness of the investors available to them on MAPs. Scully points out that start-up funds will invariably have a managed account on day one: “Hedge fund start-ups are having to accept managed accounts in order to get new assets. That’s been a real change in the last couple of years.” Rubio believes it’s horses for courses. Some managers aren’t interested but he agrees with Scully, adding that start-ups who don’t have a track record “might bend over backwards to get AUM under their belt even though it’s not ideally what they want to do”.
Fothergill has seen a two-step change in manager sentiment. Firstly, post ’08 managers became more amenable to doing managed accounts because they were looking to raise assets and widen their investor base having suffered mass redemptions. Client concentration was a problem. Secondly, he suggests that managers are hearing from major investors that they’ll only invest through an SMA. “We’re fielding a lot more calls from managers wanting to get on our platform because they’re hearing from investors who don’t want to invest through their regular commingled fund. We’ve seen a significant build-up in manager interest over the last three years.”
With the pursuit of alpha firmly on the agenda, BNY Mellon’s Ruane is bullish on the growth of managed accounts: “We see this as one of many growth areas for the investment management industry, and, of course, BNY Mellon.” Scully is slightly more downbeat, however: “I don’t think we’ve necessarily seen the extent of growth that some commentators had predicted. The trend will continue but I don’t think it’ll rocket.”
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