The ways in which investors are employing managed accounts to build their exposure to alternatives are becoming multifarious. Many of the well-established public platforms are having to cater for a wide spectrum of needs, from straightforward commingled funds for first-time investors right through to sophisticated infrastructure solutions for the largest institutional investors.
But it’s not just the structure that investors are considering; the rise of liquid alternatives means that onshore funds – UCITS, AIFs and ’40 Act funds – are becoming just as popular as offshore funds.
“What makes this more complex is understanding the motivations of the investor. What are the reasons clients are coming to us? Is it liquidity? Customised mandates? Transparency? To bring existing offshore investments onshore? There are lots of different drivers at work,” comments Martin Fothergill, Managing Director, Head of Hedge Funds, Deutsche Asset & Wealth Management.
Fothergill says that the bank increasingly views this as a liquid alternatives business rather than a managed accounts business. It is able to offer investors four different product lines:
• dbAlternatives – the bank’s traditional MAP where each external hedge fund manager is appointed as a sub-advisor
• dbSelect
• UCITS funds
• ’40 Act funds
“We view liquid alternatives as a space that includes various types of managed accounts and various flavours of regulated vehicle,” says Fothergill.
“You might have an investor that wants exposure to hedge funds, they want managed accounts and understand the benefits but aren’t in a position to pick their own managers. We would then offer our advisory services to build them a portfolio of managed accounts. The next stage of that lifecycle would be where a client is comfortable choosing their own managers. They might choose managers already on our platform, and in some cases ask us to add a manager (or managers) that they have selected independently.
“At the far extreme, you’ve got investors who already invest directly in a number of hedge fund managers and want to shift them into their own private infrastructure platform.”
What this shows is that MAP providers today must be as open-minded and flexible as possible. The concept of public platforms blindly pursuing an exercise in distribution and trying to raise as many assets as possible, regardless of what investors want, has been confined to history.
Back in May this year, BNY Mellon completed its acquisition of HedgeMark International, LLC, a provider of hedge fund managed account and risk analytic services, where it now sits as part of BNY Mellon’s Asset Servicing business.
In early 2013, HedgeMark launched its Dedicated Managed Account (DMA) solution to offer investors a fully customised route into hedge fund investing.
“For the largest hedge fund investors the dedicated account solution addresses most of their key issues associated with hedge fund investing: control, transparency and governance, and to some extent fees.
“It was a natural extension of BNY Mellon’s core servicing on assets to provide enhanced services for investing in hedge funds. The challenge in the hedge fund space is dealing with multiple counterparties including prime brokers, futures clearing merchants, ISDA counterparties: the complexity is much higher. Traditional systems that process equities and bonds don’t necessarily work for hedge funds so clients need the additional support of a customised MAP.
“Today we are working with more than 20 clients across our DMA and risk offerings,” confirms Andrew Lapkin, CEO, BNY Mellon HedgeMark.
Private mandates: full control and customised terms
When, though, should an investor decide to go down the customisation path? And should this always mean that the funds are private or can they also be commingled?
One of the important distinctions between a private platform and a public platform is that clients choose the hedge funds they want and negotiate the fees directly with each manager.
“On a traditional MAP the platform will select the manager, negotiate the discounted fees with the manager and the platform provider keeps that fee discount as their spread. Investors pay the manager fee plus in many cases a platform or access fee. In our case, clients choose the managers they want and they control the negotiation of the fees with each manager. DMAs also allow clients to negotiate how the fees are structured, including the ability to better align fees with performance. As an example, they could incorporate a fee clawback in periods of performance drawdowns,” says Lapkin.
“With DMA you can create investment guidelines specific to that one investor, similar to the long-only space. The investment manager is hired to trade a portfolio under strict investment guidelines. It may be that the investor has a social responsibility element and doesn’t want certain stock, sector or country exposures.”
Innocap Investment Management Inc. (“Innocap”) is a strategic alliance between National Bank of Canada and BNP Paribas. With more than a decade of investing in hedge fund strategies and approximately USD2.74bn in assets under advisory (as of 16 May 2014), Innocap has seen demand rise in the last couple of years for dedicated managed accounts. That said, it does still run a couple of commingled accounts on its Canadian platform and a couple on its Maltese SICAV platform, the latter being managed by Innocap Global Investment Management Ltd.
“In some instances investors are happy to open an account and share it with others but our main focus with clients lies in the dedicated managed account space,” explains Jean Baram, Managing Director, Business Development & Investor Relations, Innocap Investment Management Inc.
As at 31 October, approximately 47 per cent of its clients were pension funds.
“This is now dominating the other solutions we have on the platform. Around 85 per cent of our assets are now in these dedicated accounts and dedicated relationships,” adds Baram.
When asked what the key drivers are for investors going down this route, Baram stresses the need for flexibility.
“At the end of the day, a pension fund wants flexibility in the mandate during the lifecycle of the investment. In 2011 and 2012 in Europe they had some concerns over counterparties and asked asset managers to stop dealing with some of them.
“It’s not only flexibility of the mandate that they require; it’s flexibility of the entire investment.
“Also, they want flexibility with fees, choice of jurisdiction, transparency and liquidity. In commingled accounts you have side letters, equality of treatment, which might not suit a large institution. For us, it’s always been about customisation. Given the costs involved, you need to commit a sizeable allocation – USD35-50m for each fund. Commingled accounts are still relevant for investors who aren’t able to invest such amounts into a single manager,” says Baram.
Daniele Spada, head of the Lyxor MAP, notes that institutions are coming to Lyxor with more specific requests. He says that institutions want more thematic portfolios, concentrated exposures in certain strategies and less diversification in terms of number of funds.
“Institutional clients realise there is value in hedge funds especially when one uses them selectively and the right exposure is chosen. They can customise this exposure using private platforms. It is a trend that gives them the freedom to make informed investment decisions. They get a lot more services from a MAP that they wouldn’t necessarily get from direct investment,” says Spada.
To that end, commingled platforms like Lyxor are looking to leverage the experience and research capabilities they’ve built since 1998 to cater to the increasingly bespoke needs of investors by presenting themselves as more than just an infrastructure solution; they are investment platforms, who understand what investors are trying to achieve with hedge fund investing.
“They are asking platform providers like Lyxor for highly customised services, either just by providing them with the infrastructure, or, more frequently, by customising the mandate to meet their specific allocation needs. This extends to customising information they need to use to monitor their allocations and so on.
“They want to aggregate their hedge fund exposure with their broader portfolio allocation,” says Spada.
This need for a 360 degree view of risk exposure within the portfolio is arising as investors no longer view hedge funds as separate to their equity and fixed income allocations; they are becoming intertwined, using hedge funds as strategic overlays within the overall portfolio.
“One of the key linkages we have now that we are a BNY Mellon company is a connection to the data of the Bank’s custody and accounting clients. This allows BNY Mellon clients to request that their total portfolio flows into our risk systems so that we can provide risk analytics on the total plan. It really helps investors understand what role their hedge fund program is playing within the portfolio. It helps them view hedge funds more as active managers and less as a distinct asset class,” states Lapkin.
At ABN AMRO Private Bank, they are starting to integrate managed account technology to bring enhanced reporting capabilities to their clients’ wider portfolios.
“What we are now doing in the Netherlands for our discretionary portfolio managers – completely separate from hedge funds – is utilising the managed account technology used in our dedicated FoHF vehicle and overlaying that onto our clients’ portfolios of equities, bonds, cash, FX to give them enhanced portfolio and risk aggregation reporting,” confirms Marc de Kloe, Head of Alternatives and Funds.
Advisory services sit at the midway point on the spectrum of managed account investing. Where the public versus private debate becomes more nuanced is that some investors are using the likes of Deutsche Bank to construct portfolios of commingled funds, portfolios of bespoke funds (higher allocations needed), or a mixture of the two.
“Advisory services continue to be important for us. The pipeline that we have heading into 2015 would suggest that advisory, in combination with managed accounts, is becoming more important for a growing client base that is looking for that combination of benefits provided only by a MAP and institutional advisory group. Our public platform remains equally important, it’s just that we see a lot more requests now around advisory and private MAP solutions,” says Fothergill.
Based on asset inflows in 2014, Deutsche Bank’s investors still largely favour straightforward commingled investing.
“We have products that are advised portfolios of public (commingled) managed accounts. We have portfolios of private accounts. And we have some products that are a mixture; some are commingled managers, some are managers that are private just to that client. It’s a ‘pick and mix’ approach.
“The majority of assets are still in commingled accounts, but next year the number of private mandates is expected to rise,” states Fothergill.
Baram adds that typically, a pension plan will come to Innocap with a list of managers and ask them to suggest any others that might be worth considering.
“We see demand for advisory services more on the wealth management side where clients need help in terms of sourcing managers and constructing portfolios,” comments Baram.
The rise of liquid alternatives and growing investor awareness of hedge funds are making the managed account space more complex as the range of choices and levels of customisation increase.
But as institutions look to better integrate hedge funds into their wider portfolios, Lapkin thinks this will favour some platform providers more than others: “For big institutional investors, it makes sense for them to extend what they do on the long-only custody side to incorporate hedge funds. We think that longer term it will be the larger custodians like BNY Mellon that will play a dominant role in structuring these private Dedicated Managed Account platforms.”
