By James Williams – As more hedge fund managers, particularly start-ups and emerging managers, accede to offering managed account mandates it would appear that buy-side institutions, be they fund-of-hedge-fund firms or investment advisory firms, are trying to steal a march on the big publicly-owned banking platforms. The general premise is that these institutions are more closely aligned to investors, they understand their needs and are more solution-driven than distribution-driven.
To that extent, we are seeing something of an evolution in the managed account space as more and more institutional money gets allocated to hedge funds. In the past, investors in hedge fund managed accounts were more focused on the defensive attributes they offered: good governance, good control, segregation, liquidity, transparency etc. But as Omar Kodmani (pictured), President, Permal Group, one of the world’s leading alternative fund-of-fund firms with USD22billion in assets, comments: “That’s Managed Accounts 1.0. We feel that things have advanced quite a bit from there. The new requirements of Managed Accounts 2.0 are much more than that. It’s no longer about investing for defensive reasons but how to achieve desired investment objectives.
“Where we feel there’s a lot of scope for differentiation is in the return-seeking part of the equation (more offensive attributes). It’s not just about controlling risks but returns as well. We can generate differentiated returns by having higher quality managers on our platform, as well as boutique managers where we feel we have the operational security to take them on board and exploit the alpha generation that they can offer. In addition, we look to change the mandates with managers to try and generate higher returns, which we can do, for example, by asking them to run more concentrated portfolios.”
Factor in the ability to negotiate fees with managers, further improving overall performance, and one begins to understand how firms like Permal are bringing an investment solution approach to running buy-side MAPs.
Every manager that gets onboarded is done so with an investor mindset. This is why FoHF firms, who have the experience and expertise in manager selection, are potentially a compelling option for investors. Right now the Permal platform has 87 managers representing some USD8billion of assets; for comparison, that figure was sub-USD7billion only 18 months ago.
According to Kodmani, that figure of 87 managers is not static; each year anywhere up to 10 or 15 names will be replaced if they no longer meet the investment criteria.
“A two-year run rate is probably the average. We always seek the best return potential for our clients and if we decide after six months the investment proposition no longer holds value that’s okay, we’ll remove the manager and move on.”
Guggenheim Fund Solutions takes a different approach to running its managed account platform. Unlike Permal Group, it is not a co-investor in managers but acts merely on behalf of its institutional clients as the investment advisor. Every hedge fund manager that is selected joins the platform as a sub-advisor.
“We’re an institutionally-focused managed account platform with a fiduciary element attached to it. If you look at some of the traditional managed account platforms, they’re just trying to provide basic transparency and reporting. We have a strong focus on best practices to ensure the highest quality solution for transparency including both market and non-market risk controls,” says Ajay Chitkara, Senior Managing Director and one of the business heads at Guggenheim Fund Solutions.
“When we say ‘managed accounts,’ we mean that we set up fund vehicles where we are the registered investment advisor and can step into certain fiduciary roles at the direction of our clients.”
Controlling the investment mandate as the investment advisor is certainly a key differentiator. A lot more focus is given to analysing investment risk in the portfolio and providing more fiduciary intelligence than investors would potentially get elsewhere. This means that many institutions are a lot more comfortable with the idea of investing in a commingled mandate, rather than incurring the additional costs (higher tickets) of having separate managed accounts.
“We’ll have certain institutions that come to us and say ‘We are going to make a large allocation to a specific manager’ and if that allocation is large enough we can offer them dedicated investment vehicles. If those allocations are going to be smaller then they may have no choice but to allow for a commingled vehicle which Guggenheim can then show to other potential investors, providing economies of scale for everybody.
“Many institutional investors are comfortable with the commingled account option because they realise that we offer separation of governance from trading. They’re not worried about a manager imposing gates or having style drift, or potential valuation issues because we provide an independent oversight of everything that goes on in the account vehicle on a day-to-day basis,” says Chitkara.
Even though institutions are moving towards direct investing, be it through commingled funds or managed accounts, many will still avail themselves of consultants and advisors who have the expertise and resources necessary for a pension fund, for example, to identify which managers to invest in. Once they’ve identified those managers, they can go to a platform like that offered by Guggenheim Fund Solutions and take solace knowing that they can control the mandate as the investment advisor.
“Fund of hedge funds have built MAPs but their model isn’t to provide the centralised utility of managed accounts. It’s really to provide advisory services. They use managed accounts as a way to differentiate themselves but that’s not their core competency. Guggenheim, on the other hand, is completely un-conflicted with the role of the investment advisor or consultant
“Our core competency is operating and governing vehicles on an institutional grade platform with a fiduciary element, which allows us to assist in making more intelligent decisions around the investment risks or other parameters that institutions can’t take on,” states Chitkara.
Recently, the alternative investments division of Swiss-based Union Bancaire Privee (UBP) selected Guggenheim Fund Solutions to build out a suite of hedge fund managed accounts. Fourteen have already been launched and UBP plans to have 30 accounts up and running by year-end.
Arie Assayag, CEO of UBP Alternative Investments, says the reason why GFS was selected was because “It is an independent counterpart with a scale and credibility that matches UBP’s. Furthermore, GFS and UBP Alternative Investments share a common view on transparency, control and fee structure. We are trying as much as possible to replicate the underlying fund structure. As a result, the selected service providers will be the same as the ones used for the offshore funds – priority is thus given to the manager.”
Assayag was also quoted in the press as saying that the new partnership offered a “truly un-conflicted platform that avoids all liquidity transfer. We view this service as a new approach to alternative investments, which will enable clients to see their investments perform in a more secure manner.”
Permal views itself as having the ability to truly customise the approach to managed account investing and is using its expertise in understanding managers and their investment strategies to break new ground by creating bespoke thematic solutions.
This might involve portfolio concentration, carve-out strategies and is based on the Permal team developing top-down investment themes, after which the appropriate manager(s) is approached to exploit the chosen theme. This is an important trend because it’s putting FoHF firms on more of a front foot.
“I do think it is putting players like us in the driving seat in terms of being an activist with regards to portfolio allocation, thematic investing, choosing which managers to use and how to use them. If in the past end-investors thought that their investment partner was merely someone that provided them with access to managers that is no longer the case today. We’re shifting the influence to us,” says Kodmani.
A good example of this thematic approach to managed account investing is the US energy revolution. Kodmani says that they’ve scanned the universe of US long/short equity managers, identified the best talent, and approached those managers to run a mandate that is focused purely on identifying winners and losers in the US energy revolution.
And it seems that managers are quite receptive to this approach.
“When we are developing thematic ideas we tend to get a strong response from managers. They are willing to cooperate because for them it’s also breaking new ground. If the strategy works then they can offer it as a new product to their investors so there’s an R&D benefit to them,” adds Kodmani.
For the managers themselves, they must ensure that they have a strong operational framework in place to support managed account mandates. Key to this is automation. The world of spreadsheets and utilising myriad systems to keep track of trade lifecycles from front to back is pretty much over. This is especially so for managers who take on managed account mandates because the level of detail and additional reporting required is substantial.
SunGard has been quick to respond to this. Last year it rolled out Hedge360, a hosted integrated platform composed of various modules, all of which are designed to work in synch to give managers the operational robustness investors now demand.
“InvesTier is our investor accounting solution and is the most relevant to managed accounts. It’s a very powerful platform for managing investor allocations, fee calculations, tax reporting etc. We now have 20 global clients using the Hedge360 platform and feel good about the pipeline going forward,” explains Paul Compton, head of strategy in SunGard’s asset management business.
Institutional credibility is imperative for today’s hedge fund manager says Compton. Using automated systems on a platform that gives them transparency and control of their business is a key consideration, especially for newer managers who have the opportunity to raise assets through offering managed accounts.
“With Hedge360, managers don’t need to take on a large internal IT group, they don’t have to spend money on hardware and separate systems, and they have the ability to add different modules – and different functionality – as they evolve,” says Compton.
Deutsche Bank Fund Services is one of the industry’s leading managed account administrators. Over the last few years it has developed a highly flexible and sophisticated technology infrastructure to support the exacting demands of managed account reporting both to investors and regulators. Given that it operates two leading MAPs of its own – dbSelect and dbAlternatives – the firm is ideally placed to respond to changing market conditions.
Kristin Castellanos is the head of Product Management, Deutsche Bank Fund Services Alternatives. She notes that clients have responded particularly favourably to the fact that all reporting is now done through the bank’s Autobahn portal.
“It’s a single sign-on to all of the applications used at Deutsche Bank. When our clients log on to Autobahn they can now access a customised dashboard that consolidates all of their Deutsche Bank applications in a home page toolbar. This allows them to click on any client-based application and see all of their customised reports, many of which have been designed to be presentation-quality. These reports are often sent upstream to their investors and include attribution and exposure pie charts, bar graphs and other types of customised graphics. Today’s administrator has to be able to put these kind of value-added tools into their clients’ hands.”
A key focus of its administration capability has been the gradual build out of its middle office services over the last 18 months. The key driver for this is transparency. Castellanos confirms that Deutsche Bank systems now have the capability “to allow managers to track exactly where we are in the NAV calculation cycle. This is all about giving clients more transparency into our workflows. We have begun internal testing and should be able to offer this to clients by Q2 next year.”
As Castellanos rightly points out, with managers having to deal with so much data by virtue of regulation, or because they are running multiple versions of the same investment strategy, what they absolutely need, regardless of whether it’s a Cayman fund or a managed account, is a single view of their world.
“A fund manager wants that holistic view of the world no matter how many funds, managed account mandates they might have. We allow clients to see all their portfolios in aggregate, see their overall exposure and basically see everything they want regardless of whether they are the AIFM or not – which is important if they are acting as a sub-advisor to a managed account on a platform.”
A good point given that this is exactly the case when managers join Guggenheim Fund Solutions’ platform.
Chitkara believes that the model Guggenheim has developed will be important to the hedge fund industry, going forward: “The model that we’ve created will be the only way that many institutional investors are going to get comfortable making large allocations to hedge funds because they know we are completely aligned with their interests.”