By Simon Gray – With the fourth anniversary approaching of the onset of the credit crunch and the crisis that rocked the hedge fund industry, the growth in investment through managed accounts has proved an enduring legacy of the mayhem of 2007 and 2008. But industry members say there is much greater appreciation today than a couple of years ago that there is not a simple choice for investors between pooled funds and managed accounts, and that a range of options exist depending on their attitudes toward cost and the key benefits they seek.
An example of the evolution underway in the industry is the joint venture announced last November by OFI Asset Management and Gottex Solutions Services, the managed account provider established by Swiss-based fund of hedge funds manager Gottex Fund Management. Luma Solutions Services is a Luxembourg-based platform providing onshore managed account services to Ucits and other European funds, starting with an initial base of USD350m in assets under management.
According to the partners, Luma is the first independent platform to offer managed accounts services for both Ucits and non-Ucits onshore funds to European and international clients. Gottex Solutions Services is providing managed account and risk management services, adding to its existing offshore platform established in the Cayman Islands and bringing its total assets under management to more than USD1bn across a broad range of strategies and asset classes.
The platform aims to be the most technically advanced platform in what is becoming a crowded market, promising features including transparent pricing and integrated tax reporting. “This joint venture brings together our Cayman platform with OFI’s Ucits platform,” says Gabriel Bousbib, chief executive of Gottex Solutions Services. “We will shortly be at 25 accounts, and it means we can now accommodate Luxembourg Ucits and SIFs as well as offshore funds on the Cayman platform.”
An important aspect of the deal, according to Bousbib, is OFI’s experience in Luxembourg and European distribution capabilities. “We’re in the process of building dedicated distribution capabilities for some hedge funds on the platform,” he says. “These managers are approved by Gottex or OFI, they are benefiting from the platform infrastructure, and it makes sense in some cases to distribute these managers to certain markets in Europe as well as in the Middle East.”
The domicile of a managed account platform can be an important factor for some investors in the post-crisis environment, often depending on their own location. “In certain countries such as France, they tend not to invest in hedge funds unless they are packaged through a Ucits vehicle,” Bousbib says.
“In practice that means they will only be comfortable with a fairly narrow range of strategies. Across certain European markets, investors are often reluctant to invest in vehicles established in offshore jurisdiction such as Cayman. This reluctance is found to a lesser extent among Asian investors. In general, North American investors are indifferent to the platform’s location, while in some cases, especially in the Middle East, they actively prefer Cayman.”
To some extent Ucits-compliant structures, with their high level of regulation designed principally for retail investors, have been portrayed as a competitor to managed accounts, but Bousbib disagrees. “They are part of what I would describe as a continuum of options,” he says.
“Ucits funds are more heavily regulated vehicles that can be offered to a broader range of customers, but the constraints imposed on them, especially in areas such as liquidity, leverage, type of assets and trading strategies, will by definition narrow the alpha opportunity. It depends on the kind of investor. If you are trying to serve a more retail-oriented customer base, Ucits are more suitable, but if the strategy supports liquidity, there’s no bar on offering that liquidity to more sophisticated investors through a non-Ucits structure.”
Stefan Keller, head of managed account platform research and external relations at market-leading platform provider Lyxor Asset Management, also believes the two investment approaches are complementary rather than in competition. “Ucits involves the public oversight of asset management activities, while the managed account platform provides private oversight,” he says. “Ucits hedge funds are seen as more opaque in terms of structuring, for example the need to use derivatives to achieve the economic effect of short selling.
“The Ucits framework allows hedge fund-like strategies to be offered in a regulated environment, which helps to raise the profile of hedge fund managers, but it is nevertheless an expensive and a more complicated route. However, alternative Ucits reach a client base that has not previously enjoyed access to hedge fund strategies.”
Bousbib says the trade-off between the advantages sought by investors in areas such as liquidity, transparency and control of assets, and the cost of providing them, will vary from client to client. He likens the question to the optimum number of police officers that should be hired to ensure safety in a small town: “You could argue that the optimum number is one police officer per household, but of course that’s not sustainable, because the cost is extremely high. Similarly, in an ideal world, the perfect investment structure is one vehicle per customer, but that has cost consequences based on the size of the investment, the strategy and the number of service provider agreements that this entails. Everything will be a trade-off.”
There is also a range of options depending on the precise benefits that the client is looking for. “For instance, the investor could be in a fund of one, the sole investor, but all the oversight, controls, and governance remain largely in the hands of the investment manager,” he says. “They can retain the services of a platform operator, but is a cost of 35 or 40 basis points warranted to monitor what the investment manager is doing? For vehicles with a single investor, the expense of services such as administration, IFSA agreements and prime brokerage may make investment less cost-effective than in a commingled fund.
“Commingled funds have their own trade-offs. How liquid is the underlying strategy? What mechanisms exist in the event of excessive redemptions? A very binary approach to managed accounts is a false debate. There are many different reasons why investors might prefer managed accounts. For example, they might like a strategy, but the manager doesn’t employ sufficient leverage to the investor’s taste, so they set up a separate account using more leverage. They may prefer a slightly different investment strategy from that of the flagship fund. They may have operational concerns that the manager is not willing to address.”
Bousbib notes that Gottex Solutions Services has devised its own solution to meet investor concerns about the impact on liquidity of investing through a commingled vehicle. “The idea was to find an approach that would treat everyone fairly, both investors that are redeeming and those that are remaining invested,” he says. “The usual solutions of suspension and gating tend to protect the investors that stay at the expense of those who redeem. Conversely, solutions that basically involve selling the most liquid part of the portfolio favour investors that are redeeming.”
The idea behind One-Click Partitioning is to try to balance the conflicting needs of both groups of investors. “For every managed account we predefine a redemption threshold, depending on the type of strategy. With merger arbitrage or liquid equities, it could be as high as 70 per cent, but for mortgage-backed securities it could be as low as 20 per cent. If the threshold is triggered, the account is automatically partitioned into two, and the account that represents the interests of the redeeming investors is liquidated.”
The importance of this, Bousbib argues, is that it prevents investors feeling obliged to redeem their investment because they fear getting stuck with illiquid assets if they don’t. “It acts as a safeguard and avoids unwanted redemptions,” he says. “During the 2008-09 crisis investors were afraid to be the last ones holding the bag, so everyone rushed for the door. Here they know there will not be arbitrary decisions by the board or the manager – it’s all predefined.”
Keller says that while transparency, and the risk management linked to it, is perhaps the primary advantage sought by managed account platform investors, it’s important not to ignore the importance of the weekly liquidity offered by most accounts on the Lyxor platform in allowing investors to fine-tune their asset allocation in a much more timely manner than is possible using pooled funds.
“When unexpected risks arise, such as unrest in the Middle East and a sharp rise in the price of oil, investors want to react and anticipate future movements, and might not want to wait a month or quarter to do so,” he says. “Liquidity remains paramount to keep investors’ asset allocation in line with the views they want to express through their investments.”
While he acknowledges that increased liquidity makes it possible for investors to use fund holdings as ATMs when they need cash quickly, Keller believes it also makes it easier for them to return to the market more quickly. “After a sharp drawdown we also see investors returning to the platform fairly rapidly,” he says. “Overall the money is quite sticky. We have seen this trend since the end of August and early September 2010, with fresh inflows and rising assets under management supported by positive performance.”
He adds: “The main lesson of 2008 is that hedge fund investors have to do their job properly and ensure there is no mismatch of liquidity. The managed account platform permits that sort of asset-liability management. Our investors have access to weekly liquidity, and they use it. Liquidity allows you to tweak a portfolio, to switch between strategies and follow new investment themes at the right time.”
Keller believes that one of the ways in which managed account platforms can distinguish themselves from competitors, and from the do-it-yourself approach, is the level and quality of service they offer.
“It’s about areas such as risk management and state-of-the-art reporting, which we will enhance further in 2011 by offering access through the web site,” he says. “It’s about giving clients access to dedicated research and providing more investment insight. This has a cost, but Lyxor has continued to invest all the way through the crisis because when competition is strong, you have to offer investors better service.”
By contrast, Maples Fund Services chief information officer Tyler Kim argues that the sheer diversity of client requirements in areas such as reporting make it hard to devise a satisfactory common solution.
“Every investor is different,” he says. “They are similar in that they want P&L and position data to be readily accessible. However, when you come to things like performance calculations, some may use an internal rate of return methodology, while others may be satisfied with month-over-month changes in NAV adjusted for cash flows.”
“They are all very specific about what reporting they need for their board, and we have to follow that. There is such huge variation and complexity that we have found that the one-size-fits-all approach just doesn’t work.”
Karen Watson, global head of data management at Maples Fund Services, adds: “Most clients are focusing on risk management and exposure reporting as well as performance, but when you drill down beyond the overall themes, the detail is absolutely unique to each investor. That’s where a managed account platform is not as accommodating as a bespoke system.”
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