By James Williams – Despite the operational challenges that face managers who decide to take on managed accounts, it seems almost inevitable that as more institutional money comes into the alternatives space, managed account AUM will continue to climb. This is because capital raising, for all but the biggest and best managers, remains an almost Sisyphus-like endeavour.
According to a recent industry report, assets on the leading managed account platforms rose 15.9 per cent between June 2011 and June 2012 to USD72.8billion. Managed accounts are here to stay. However, to what extent they will supersede commingled funds remains to be seen.
Ed Gouldstone, Head of Hedge Fund Product Strategy at Linedata, estimates that the firm has spoken to around 30 per cent of its clients on matters pertaining to managed accounts.
“In most cases this has been a result of funds attracting new investment but maybe 10 per cent has been a result of existing investors asking whether they can move across to a managed account structure,” notes Gouldstone.
Part of the catalyst behind growth in managed accounts is a function of herd mentality. Investors look at what everyone else is doing and decide they should do the same.
“There’s a clear trend by large institutional investors with meaningful hedge fund portfolios, or who are planning to build meaningful hedge fund portfolios, to use managed accounts. It’s something we’ve seen building over the last two years,” observes Martin Fothergill (pictured) managing director, dbalternatives managed accounts platform, Deutsche Bank.
Eric Weinstein is a managing director at Neuberger Berman and Chief Investment Officer for the NB Alternatives Fund of Hedge Funds team in New York. He believes that institutions with significant assets and who have added knowledgeable staff will increasingly turn to custom portfolios – as opposed to investing in commingled managed accounts.
“Our first custom portfolio was launched in 2004. Our flat decision making structure and the oversight of each relationship by a senior member of our investment team have allowed us to effectively serve this client base,” says Weinstein. He notes that institutions wanting managed accounts with underlying hedge fund managers do so because they place a high priority on liquidity, control, and operational issues.
However, there’s no sign, yet, of a wholesale shift in investor mentality towards customisation, and indeed, Weinstein is pragmatic on the overall growth prospects of managed accounts: “We believe that managed accounts with underlying hedge funds have a permanent place in the hedge fund landscape, but we’d be surprised if they become a majority of the industry’s AUM.”
It seems that the issue today is not whether investors want managed accounts, but how they want them. Do they use an existing platform, or do they build their own?
“There are a lot of complexities around customising platforms. It really depends on what level of fiduciary responsibility the investor wants to take: would they prefer someone like Deutsche Bank to operate it for them or to have a toolbox provided by the platform to help them build it in-house?
“We tend to see clients asking us to run everything for them and not have too much customisation because it is more complex and takes longer to set up. The reality is there may be too many choices and too much responsibility for them to assume,” says Fothergill.
One strategy that has a long association with managed accounts is managed futures. The fact that CTAs trade liquid global futures markets means that operationally they are often regarded as a “pure” managed account. Each investor has a completely segregated account held with a Futures Commission Merchant (FCM) of their choice. They have full control of the assets.
The investor simply gives the manager Power of Attorney over the sub account to put trades on as per the strategy. If the investor isn’t happy with performance, they instruct the FCM to revoke the POA.
This point is critical, especially in today’s climate of counterparty risk concerns.
London based Katmai Capital Advisors launched their inaugural trading programme, Commodities+, in October 2012. The programme is offered exclusively via managed accounts and as the founder of Katmai, Michael Cook, explains: “It’s not that managed accounts are less risky, it’s the fact that they put more of the risk under the control of the investor. Is there credit risk? Yes. But rather than it being the manager’s choice, it’s the investor’s choice. That’s the key factor.”
Cook was formerly an institutional fixed income trader. Following his 2007 switch to trading futures he became a fan of the managed account structure, something he sees as superior to the offshore fund structure: “When I was living in the US I found it difficult to understand why managed accounts weren’t more popular in Europe, where they traditionally have less traction. In the US, the structure is common for CTAs and I can’t see why a whole range of hedge fund strategies shouldn’t also be suited to this structure. Whilst it might be difficult to run private equity or real estate as managed accounts, strategies such as equity long short could certainly be managed in this way.”
The co-alignment issue
This could help overcome some of the disadvantages that currently exist when managers are asked to shoehorn their existing fund into a managed account. Jeff Holland, co-founder of Liongate Capital Management, a London-based FoHF firm, thinks there is a place for both commingled funds and managed accounts, but is quick to stress the difficulties investors might potentially face by choosing the latter.
“The manager isn’t able to make use of cash flow, you might get tracking issues, and of course, the manager’s own capital is invested in the commingled fund,” says Holland. This ensures a co-alignment of interests that don’t exist in a managed account. “It could create potential conflicts of interest when allocating trades. Does the manager give preference to trades in the commingled fund? It’s an important consideration because it could create a lack of focus,” adds Holland.
Perhaps the biggest disadvantage to managed accounts is the restricted choice of managers available to investors compared to commingled funds. Admittedly, platforms are expanding their range of strategies, but within the grand scheme of things quite a few of the larger managers aren’t interested, precisely because they don’t need the capital.
Moreover, many would prefer to maintain a lack of transparency in the portfolio for strategic reasons; a long/short equity manager might not be keen on having his short positions fully disclosed for example.
What is indisputable is the transparency benefits managed accounts offer. Lyxor’s commingled MAP is one of the largest in the industry with approximately USD11.5billion in AUM. With over 100 managers on the platform, it is in a unique position to analyse how managers adapt their portfolio trading as markets fluctuate.
Stefan Keller is head of MAP research at Lyxor. He notes that within the long/short equity space, average net exposure has shifted dramatically in the last 12 months: “Hedge fund managers had a cautious view on Europe in the first half of the year, leading to low directionality and leverage in their portfolios. However, we noticed that this started to be adjusted upwards during September. Average net long beta exposure is now 20 per cent; compared to last year that’s a 20 per cent swing.”
Lyxor’s website portal, dedicated to managed account investors, has proved highly successful this year says Keller, with literally hundreds of clients using it as a daily tool for making better-informed allocation decisions.
When asked what further technology developments were in the pipeline, Keller says the next step will be to aggregate data at the FoHF/client’s allocation level for those running portfolios of commingled managed accounts.
Says Keller: “We plan to launch this next year. It will give investors an aggregate view across all hedge fund positions and allow them to analyse previous performance through back-testing capabilities.”
Enhanced transparency and more frequent reporting give investors a wealth of information, but they need to know what to do with it. This is especially true of those using bespoke mandates. Consequently, data aggregation has become an important focus for service providers.
Jim Cass is vice president and managing director, SEI Investment Manager Services, one of the industry’s leading operational outsourcing providers. He comments: “Our investor dashboard aggregates data across multiple mandates and allows investors to make best use of the transparency they receive. What we’re seeing is that they’re beginning to categorise investments their underlying managers are making in the managed account. For example, when they want to filter down to a specific industry e.g. energy, using the investor dashboard they can quickly find out what their exposure is, and drill down further to oil, gas, clean energy etc.”
End-users are now able to aggregate data the way they want and generate their own customised reports. This is enhancing their investment process. By keeping on top of their investments investors are able to gain insights on performance, risk, and ultimately make more decisive portfolio management decisions.
“For those instances when a client needs more customisation, our view is we want to put the tools in their hands. We’re in a position to get clients that information on a trade day basis so they can go in and see the impact of the underlying managers’ activity.
“Our objective is keeping that information as close to real-time as you can get it,” adds Cass.
Customisation: commingled versus bespoke portfolios
One of the key drivers post-08 for investors wanting segregated solutions, according to Holland, was to avoid co-investor risk. Motivationally, that appears to be changing. “Today, the objectives of sophisticated investors have become more nuanced. Managed accounts are being used more to tailor a mandate as opposed to any fears over co-investor risk,” says Holland, who continues: “Our flagship fund is a multi-strategy fund. An investor might say they want a more concentrated portfolio targeting a higher return, maybe they have a different liquidity preference, or maybe they want to focus on a specific strategy like global macro, which has been a big theme for some time.”
Most investors who choose managed accounts are happy with a commingled structure as they still get to enjoy the benefits of additional transparency. However, customisation – be it in a single mandate or a full blown portfolio – is building traction as pension funds look to diversify their holdings.
These investors lie at the most sophisticated end of the spectrum. They might have already been investing in commingled funds with a FoHF, perhaps even in a fund-of-one (where the FoHF approaches a manager to set up a mandate for their investors alone but where the manager retains control of the assets). Tentatively, some are switching their attention away from FoHFs and investing directly via the managed account route.
Holland confirms that the firm is in active discussions with three large institutions. All three want bespoke portfolios of global macro managers. But whereas two of them are happy to hold these investments in the underlying commingled funds, “one of them wants a portfolio of managed accounts, and they understand that this limits their manager universe,” says Holland.
Cass believes the appeal of managed accounts depends on the underlying strategy type as far as the manager is concerned: “When you do managed accounts in less liquid strategies then you’re stuck splitting your trades with multiple custodians, and unless you have a big enough mandate, it might not be worthwhile pursuing. It’s much easier running a managed account for a LSE strategy than it is for a bank debt strategy.”
Rahul Kanwar, senior vice president and managing director of alternative assets, SS&C GlobeOp, says that they’re actually starting to see more product coverage specifically in areas such as bank loans, and derivatives-based strategies. This shows that the space is steadily evolving. As a result, it’s putting more of a technology/operational burden on administrators.
“What this requires, from an administration standpoint, is a global organisation. You can’t tell a MAP that you can’t support a manager they’ve onboarded from Asia. You have to handle all markets and all types of asset classes,” says Kanwar, who notes that the capabilities of MAPs and administrators have “improved tremendously” in recent years.
“The challenges come because you might have different valuation processes for different asset classes, different timings for reports. Ultimately, whatever the mandate, you have to bring all the data together in an accurate and timely way, and make it look the same. It has to be credible. Whether it’s a monthly or daily NAV, a P&L report, reconciliation, risk reporting: they all have to be consistent despite the sources of data, and make sense when viewed together.” GoMAP is SS&C GlobeOp’s main operational infrastructure for handling these increasingly sophisticated managed accounts across the middle and back office.
Technology and administration are the two pillars of expertise within SS&C GlobeOp. On the one hand, GlobeOp has a long history of servicing some of the industry’s largest managed accounts. On the other, SS&C’s cloud-based capabilities – web portal reporting, mobile applications – are being leveraged to benefit every client on the GoMAP platform.
Kanwar says that the strategy for evolution on the GoMAP platform is three-fold. The first ties in to Cass’s point regarding quality of reporting and accessibility of data. “That means enriching our web presence and mobile presence. We brought out an Android app a few months ago for example, to ensure that all of our clients – on managed accounts or otherwise – have access to data wherever they are.”
Continues Kanwar: “Secondly, we continue to expand GlobeOp’s existing command and control structure. We use a system called GoCheck to manage every aspect of the process. If a client is a third party MAP with 40 different managers it means you’ve potentially got 40 different trade files coming to you at different times, with different NAV requirements – you need to be able to control that process carefully.”
The third big area of focus is regulation, in particular Form PF and FATCA in the US. “One of our big focuses has been to become a custodian or warehouse of all this data coming in. We want managers to comply with regulatory reporting requirements directly using our systems; a one click web-enabled solution that allows them to generate the report and send it straight to the regulator.”
Linedata’s Gouldstone says that regulation is changing the way service providers interact with their clients. Previously it was a case of providing the software tools for managers to monitor activity both in the flagship fund and the managed account(s). Now, with so much operational complexity and regulatory compliance, things are moving towards a service-oriented model:
“Rather than just having a piece of technology they want the expertise that goes along with that. We are trying to tailor our solutions to include service components to help our clients better deal with these [regulatory] challenges,” says Gouldstone.