By James Williams – Greater sophistication among hedge fund managed account investors is changing the way managed account platforms (MAPs) operate. Flexibility and customisation are at the forefront of the offering among independent platforms, free of the regulatory manacles being imposed on banks.
What appears to be driving this shift towards a more investor-centric model of customised solutions, is the changing nature of the investor. Increasingly, large institutions – state pension funds, insurance companies – are looking to allocate directly to managers they favour via bespoke single mandates, or, to a lesser extent, via portfolios of mandates. They have the assets to do it – most other investors do not.
Chicago-based independent platform, AlphaMetrix, has seen its assets grow from USD6.5billion at the end of 2011 to USD8.3billion according to its president and CEO, Aleks Kins (pictured), who estimates that half that growth has come from bespoke mandates. The number of managers on that platform has risen from 134 to 168.
Then there’s InfraHedge, the State Street-owned MAP that launched early last year and which has already raised USD7.6billion. Add Sciens Alternative Investments’ platform to the mix – where AUM has grown from USD450million to USD700million over the last 12 months – and the signs are that momentum on independent platforms is building.
“We keep investing in the firm and building our technology. This allows us to be more flexible and work with more strategy types. Early on we focused on liquid exchange-traded derivatives. Now we’ve expanded our capabilities to cover the entire spectrum of instruments,” confirms Kins, who adds: “I also attribute the growth to very large investors who are embracing the need for transparency.”
Michael Newell is a London-based partner at law firm Norton Rose. He agrees that platform sophistication is improving, but in his view the managed account space remains a mixed bag. He sees numerous institutions moving away from managed accounts as well as new entrants.
“We’re seeing institutions becoming more confident with pooled funds again – for every institution that wants a managed account there’s probably another saying they don’t have the people or advisers in place to be able to do anything with the additional visibility.”
Newell’s point is that investors have to decide whether managed accounts are value for money. “One of the questions I always ask clients is: ‘Given the extra costs of being on a MAP, what’s in it for you? If you get all this extra transparency and reporting, what are you going to do with it?’”
Demand for customisation growing
John Godden, Head of Managed Account Platform, Sciens Alternative Investments, believes that large institutions are increasingly using outsourced MAPs to produce bespoke mandates, and sees it as “absolutely the major growth area in the managed account space”, but admits that investors are also coming in as “more generalist allocators”. Currently, the platform’s AUM is split 50/50 between public and private allocations:
“Half are coming to us and being very prescriptive, saying ‘We want that manager, we want this level of risk (which might be different to the benchmark fund), we want these controls, off you go’, and we create the account.
“Others are saying, ‘I’d like a commingled portfolio of managers on your platform, and I’m going to use the fact that you can give me T+1 information and I know exactly what risk I’ve got in my portfolio every day’. So it’s half and half between prescriptive users and commingled portfolio users.”
This raises a tricky point for managers. On public commingled platforms, the manager only has to concern himself with one mandate. However, as investors start to get more serious about customisation, a top-line hedge fund manager could find himself running several single-investor mandates, each with their own rules, alongside the flagship vehicle. This has the potential to create an administrative nightmare.
“That’s a perceptive point and you’re absolutely right – no manager likes different structures of managed accounts. Operationally they want things to be as painless as possible,” says Akshaya Bhargava, CEO of InfraHedge. “The type of structure we have set up means we can make it as painless as possible for managers. If a manager were to set up five or even 10 managed accounts for different investors on our platform they would all operate similarly in terms of reporting. All we want is a data feed from the manager, the prime broker and administrator. Once that’s in place, the manager doesn’t have to worry. It’s in everybody’s interests that we try to make it as easy as possible.”
Man Group’s managed account platform has over 80 managers. Having acquired fund-of-funds firm FRM this summer, the world’s largest listed hedge fund manager has integrated FRM’s operational risk management expertise into its managed account offering.
Stephen McGoohan, Head of Managed Accounts at Man Group’s FRM, says: “More and more investors are selecting FRM to design bespoke solutions using managed accounts. Given FRM’s investment capabilities, we continue to innovate and design bespoke mandates for clients based on a deep understanding of the investor’s needs.”
Nevertheless, most investors still heavily rely on the expertise of a MAP provider like Man Group or Deutsche Bank and are perfectly happy with commingled solutions. “Ultimately, they don’t have the size, resources or technology to go it alone. The majority of the USD8billion in platform AUM is allocated through discretionary or advisory managed portfolios,” confirms McGoohan, who adds: “We have a research team of 20 people and a portfolio management team of 15 people, meaning we have the breadth and scale needed to make fiduciary decisions on behalf of clients. This year we’ve launched several products of managed accounts to meet specific client needs, including providing diversification and non-correlation to long equity exposures.”
Until recently, the way investors allocated to managed accounts was two-fold: either directly into commingled public platforms like Deutsche Bank’s dbalternatives, or by building their own platform infrastructure and choosing their own managers and service providers.
But as MAPs have started to evolve, so have the choices available to investors. One trend that Martin Fothergill, managing director, dbalternatives managed accounts platform, is starting to see is the “hybrid” investment, and this, he says, is creating a “blurring of the lines” between solutions.
“Quite a few clients are saying, ‘We like 10 of the managers on your platform but there are four other managers that we’d like to have, can you onboard them for us?’ There are advantages to having this mix-and-match solution where investors are holding some commingled accounts, and some bespoke accounts. Structurally it all looks the same, the risk engine we use is the same, reporting is the same.”
Adds Fothergill: “It’s basically a hybrid solution that lies between investors just using managers on our platform, and making that significant jump to having their own platform of managers.”
Newell says that this year it’s been a case of platform providers becoming more sophisticated to offer customised services to institutions as opposed to any tangible demand from investors: “I think it’s more an evolution of the industry where platform provision is improving.”
So what are independent MAPs doing to ensure that when pension fund ‘X’ has done its due diligence and is ready to commit USD1billion, it chooses their platform?
Manager-centric becomes investor-centric
The most obvious structural shift in focus in independent platforms is away from the manager-centric model – where distribution and raising AUM is the name of the game – toward an investor-centric model. Bhargava says the reason for InfraHedge taking this approach was on the back of research, which led them to conclude that tomorrow’s hedge fund investor base would be dominated by institutional clients.
“Taking that philosophy to its logical conclusion, what it means is you have to give the investor maximum flexibility; that’s what large institutions want. They don’t want to be presented with a pre-selected group of managers, however good they might be, because different institutions have different objectives. They want the freedom to choose their own managers.
“I believe the model we have at InfraHedge is the kind of model that appeals to institutional investors and represents the next generation of managed account platform,” opines Bhargava.
By default this means that platforms, by utilising an open architecture that allows them to handle different service provider relationships, fund structures etc, are becoming necessarily complex entities.
“Investors want the freedom to choose their own domicile, to negotiate their own commercial terms with the hedge fund manager. We don’t select managers, have pre-determined structures or domiciles, and we don’t charge any fees to the manager,” adds Bhargava. “It’s completely driven by the investor. They decide everything and we then set it all up and run it for them.”
This manager-agnostic philosophy is echoed by Godden: “It’s not our job to care about the quality of manager that an investor wants to run a mandate with. We don’t make value judgements about whether one manager is better than another. As long as there’s enough money going into a given mandate to make it function effectively, we’re immune as to what investors do.”
Kins is well aware of the cost implications of single-investor mandates. To that end, AlphaMetrix has been aggressive in building “an institutional offering that has allowed us to reduce fees down to 10 basis points. If you take an institution allocating 30 per cent to alternatives, that actually equates to 3 basis points across their whole portfolio.”
Not being affiliated to a bank is also helping independent platforms, with Godden confirming that it’s in the process of onboarding 11 managers. One of the most recent was Citi Capital Advisors’ event-driven fund. Funds like this are going to Sciens to resolve regulatory or governance issues. The platform, says Godden, is being used as a utility “by people like Citi who want to have a new style of fund vehicle, but for various reasons are unable to build it in-house because of Dodd-Frank issues etc.
“One of the advantages we have is that we’re not a bank. For example, from a regulatory perspective, we are bringing on a manager who has money from a wealth manager but who needs an independent MAP. They originally went to a bank platform but found they were unable to hold the swap. So we’re in a good place right now not being a bank platform. It resolves a lot of regulatory and practical issues for clients.”
AlphaMetrix appears to be taking the investor-focus approach one step further: by looking at investors’ portfolios and identifying where they can benefit from extra transparency in managers they like and are perhaps already invested in.
“As we work with larger groups, we’re not trying to convince them of new managers, but to provide them with transparency on their existing portfolio. That’s where we’re seeing the biggest growth. We’re working with them to turn the managers they like transparent,” says Kins.
The firm has invested heavily in technology to adapt to the growing transparency demands of investors, who are now beginning to ask for managed account mandates in a wider range of strategies. Clients are getting so excited about having daily or even intra-day valuations in their managed accounts that they’re asking AlphaMetrix if they can extend such transparency to their long-only portfolios for what Kins calls a “total portfolio solution”.
“For us the two buzz phrases are “continuous monitoring solution” and “total portfolio solution”. Our technology allows us to provide scale, it brings down cost, and it’s easier for clients to start aggregating data. Even if five different brokers are being used in a managed account, you can aggregate data from all five into one place allowing you to see a total picture.
“We’re now working on technology to allow for this [wider extension of managed account transparency across the whole portfolio]. We aim to roll out a fully integrated solution at the start of 2013.”
The ability to adapt a model that was built for one kind of client to a range of different clients represents both a strategic and structural challenge says Bhargava. This is especially so for open architecture platforms where the end investor can literally decide on structure, domicile, trading rules in the mandate. From a transparency perspective, this is a substantial undertaking.
“We’ve built our own reporting systems. We’ve invested a lot in data discovery software, which really deals with the issue of how to present information in a readable and understandable form from vast quantities of data.
“There’s a lot of complexity in the numbers. The point of offering daily reporting and analytics is to help investors make better portfolio decisions. You can’t just provide the information; it needs to be actionable,” comments Bhargava.
Sciens’ MAP is about to launch a T+1 portfolio management solution as it concentrates on building out new front-end tools to benefit managers and provide investors with more granular information. “It’s basically a build out of our risk engine into portfolio and risk management tools for end investors to take advantage of,” states Godden.
Regulation – catalyst for growth?
Aside from the transparency and control benefits, regulation could also act as a catalyst for further growth in this space. Take the AIFM Directive; presently, managed accounts do not fall within the definition of an alternative investment fund. Therefore, if a New York-based manager, for example, is attracting the interest of large European institutions, they might decide to keep their offshore Cayman fund for US investors only and insist that those European institutions have managed accounts.
As Michael Newell points out, why would a US manager with only a handful of European investors want to go through the effort of registering their fund onshore under the Directive?
“You might find Asian and US managers cherry-picking good European clients and putting them into managed accounts rather than into the commingled fund and therefore avoid the Directive altogether,” says Newell.
As for the future development of the managed account space, Bhargava emphasises the importance of flexibility among platform providers: “Collectively we have to deliver the product that our clients want. We cannot force them to buy the products that we have. You have to ask investors, ‘How do you want this to work?’ and we will build it for you.”
For AlphaMetrix, the future lies in “manager transparent funds”, which will give investors the same levels of transparency in flagship funds as in managed accounts.
“That is the future of MAPs, because whether they are commingled accounts, funds-of-one, bespoke accounts or flagship funds, the key is to have all those transparency controls and checks and balances in place. We’re really evolving to become transparency providers,” asserts Kins.