The surge of interest in managed accounts over the past two years has opened up the market to third-party investment platforms offered by a range of providers, including notably investment banks but also fund of hedge funds managers and fund administrators, that offer investors a broad range of middle- and back-office services including portfolio monitoring and risk management that otherwise they would have to undertake themselves or source separately from third-party providers.
The expression ‘platform’ covers various different kinds of service model. Tim Thornton, managing director for product and strategy at administrator Butterfield Fulcrum, also uses the term ‘utility’ to describe the Altinus platform that the firm launched earlier this year, in response, he says, to demand especially from big investors seeking protection for problems ranging from liquidity mismatches and capital lock-ups to outright fraud.
“Although managed accounts solve a lot of those problems, they create a set of problems of their own,” Thornton says. “An investor wanting to move to managed accounts currently really has two options, either to build their own platform or rent an existing one. To build your own platform will mean having to employ a large number of staff, receive a massive amount of data and do something with it, because you’re assuming extra fiduciary risk.
“A classic fund of funds investor tends to be good at selecting managers and monitoring performance, not at analysing massive volumes of data daily. It requires a big ramp-up in resources and fixed costs, and it distracts investors from their core business. The other option is to rent one of the existing platforms, of which there are a fair few.”
However, Thornton argues that the nature of many of the platform providers creates fresh issues for these investors. “The overriding one is that all those platforms are in some way conflicted if you are an allocator,” he says. “They are either bank-owned, they were built primarily to create structured products, or third-party investors suffer different liquidity or terms from the sponsor of the platform. Other allocator-sponsored platforms may be run by their own direct competitors.
“In addition, these platforms also tend to impose very high charges. They bundle a lot of services together, make the investment selection and create a portfolio, but that’s what an allocator is really getting paid for. Not only is the platform provider conflicted but the investor is paying for an extra service they don’t need and that they are in fact performing themselves.”
Thornton says Butterfield Fulcrum set out to offer something different. “As an administrator we already provide administration services to a lot of managed accounts, and we’re familiar with turning things around on a daily basis,” he says. “We have a great risk and transparency system that can monitor investment guidelines and limits and the alerts around that, so we’re in an ideal position to provide an independent utility to on to any allocator. It enables them to do what they’re best at, selecting managers and allocating capital, while we provide middle- and back-office for their operations, providing full transparency and reconciled reporting. They won’t be sifting through hundreds of items of position-level data.
“We can report all their exposures, risk statistics, benchmarking and liquidity for each managed account, as well as their aggregate holdings, by extracting position-level data from each underlying managed account. And we can do it at a lower cost than existing platforms because we’re not trying to provide investment advice or selection. It’s a cost-effective way of giving allocators a managed account infrastructure and all the benefits that go with it without them being forced to share information with their competitors or use conflicted platforms. We’re not promoting any particular managers or strategies, we’re just providing the infrastructure.”
Meanwhile, some members of the industry say the initial rush to embrace the managed account concept in the wake of the turmoil that shook the industry two years ago has given way to a more complex and nuanced approach to obtaining the benefits investors seek. For example, chief executive Gabriel Bousbib of Gottex Solutions Services, the managed account platform launched by the Swiss fund of funds manager, argues that investors and managers no longer face a simple black-and-white choice between pooled investment structures and segregated accounts. A broader range of options may be available, depending on what the investor wants and the responsibility they are willing or able to manage and pay for.
According to Bousbib, the accounts currently on the GSS platform include not only classic managed accounts but what he calls “transparent funds” that do not offer all the features of a fully-fledged managed account but provide investors with the kind of position-level transparency that is not usually available with pooled funds.
“The evolution we are seeing in the market is that people are understanding that rather than a binary decision between fully-fledged managed account or nothing, there is a need for a continuum of solutions,” he says. “The continuum includes transparent funds, which provide position-level transparency but not the governance oversight of a managed account, and lower levels of transparency.”
Bousbib describes as “knee-jerk” the reaction of many hedge fund investors in the immediate aftermath of the liquidity problems encountered by many hedge funds (and as a consequence the funds of funds that invested with them) as well as the twin shocks of the bankruptcy of Lehman Brothers along with its prime brokerage business and the discovery that Bernard Madoff’s USD65bn investment business was an empty sham.
“Initially many large investors, including ourselves, believed that a managed account was the only answer,” he says. “Now the approach is much more nuanced, as people appreciate that in some cases managed accounts are not practical or not necessary in the light of the extra cost and the constraints that they impose compared with the value they add.
“While all large investors seek stronger governance, improved transparency and strengthened oversight, there are a number of solutions to those issues. Apart from managed accounts, there may be other ways to achieve, at least in part, mitigation of risks with respect to governance – such as through a properly-formed board of directors, or through a fully independent pricing process. There are various mechanisms that need not involve managed accounts.”
Bousbib expects this trend to continue to develop over the next couple of years. “Rather than a product-centric approach, investors are telling providers that they want ways to improve governance, control and transparency,” he says. “The means could include improving the legal documentation of a commingled fund to embrace stronger governance, more independent directors, more independent pricing of the portfolio – all the way to a managed account.”
He is echoed by Aleks Kins, chief executive of platform provider AlphaMetrix, who says: ”Within the marketplace there is no simple solution to meet all the needs of investors and managers. To a certain degree there is a diametric opposition in that hedge funds can’t supply unlimited managed accounts, and not all investors can meet the manager’s minimum requirements for a managed account.”
Kins notes that even if they do meet the requirements, not all investors are capable of or willing to embrace the responsibilities that managed accounts entail. “Many investors that may have started out looking for managed accounts are finding out that operations, technology, research and due diligence are difficult tasks that can take a lot of manpower and resources,” he says.
“As a managed account platform our approach is to offer really open architecture and to work with different-sized groups with different needs. What’s really emerging is a desire for governance. Managed accounts aren’t necessarily the holy grail, but it is a way for investors to obtain that governance, because a managed account is in the investor’s name and they can control the assets. But that may be more than what most investors want to take on.”
To move from investment in pooled funds to taking on managed accounts can be a culture shock for investors, according to Simon Hookway, managing partner of MAG Consultancy, which has assisted a number of new entrants to the market with the design and construction of their managed account platforms. “It’s a learning process, because many of these people have been raised on a diet from the manager of top five longs, top five shorts and some weird geopolitical diatribe cut and pasted from the pages of Newsweek, once a month, 15 days late,” he says.
“They’re going from that world and over-reliance upon self-verified time series data that only reveals issues, good and bad, slowly over time. They’ve been starved of decent cross-sectional information about individual managers or their peers. As a result, a lot of the risk management software services and analytical systems that have grown up to over-analyse this vast data set are completely incapable of handling this new granular world.”
However, Hookway says tools that can help investors analyse the new range of data they are receiving do exist, and that allocators can learn how to make use of this information. “There’s an adjustment process for that education, and money needs to be spent on the systems,” he says. “Only in that way will they derive the real benefits and be able to pass them on to their investors.”
“These systems handle position-level data and interpret both facets of the risk management problem as it applies to alternatives, and arguably to all investments: Am I diversifying my portfolio, and is that portfolio therefore diversifying everything else I own? And much more importantly, is this manager keeping the promises they made to me?”
Hookway notes that a common error among investors is not to ask too many questions of managers as long as they are making money: “The transparency in managed accounts means you can see whether the manager is making money in the way he says he is. If he is, you can have a higher degree of confidence in giving him more money, and that is a good thing for investors because their expected return and indeed their actual return is raised for a given risk budget.”
This greater potential scrutiny arguably places increased pressure on managers, but platform providers report a continuing willingness on their part to offer managed accounts, even among top industry names that in the past would have been considered unlikely to do so. Nathanaël Benzaken, managing director and head of managed accounts development at Lyxor Asset Management, notes that the world’s largest platform has added partnerships over the past year with firms such as Caxton, Tudor and recently Barton Biggs’ Traxis Partners.
“We have been convincing managers who never considered managed accounts before,” he says. “Now they have acknowledged that managed accounts are a respectable route by which to grow their assets. It’s like a snowball. If you have firms like Caxton, Tudor, Mariner and Marathon on board, it tells you that any manager can accept it. Second, it tells you we can not only run a liquid CTA strategy but also more complex ones like distressed, with Marathon, or even fixed-income arbitrage with Mariner.”
In April Lyxor added to its platform a China long/short equity fund run by Jim Chong for Martin Currie. Says Benzaken: “We went to Martin Currie and asked them to design a liquid large to mid-cap long/short equity strategy focusing on greater China, and they came up with a new product that they run exclusively for us. We wanted a manager offering exposure to China in a liquid and volatility-controlled way, as opposed to long-bias strategies, and there aren’t many managers capable of doing that. Going forward, when we can’t find the right product available, we may again ask talented managers to design a strategy for us.”
Dermot Butler, chairman of administrator Custom House Global Fund Services, agrees that the circle of managers willing to run managed accounts has expanded, but cautions that there are limits to the range of strategies that can be accommodated. “One must recognise there are some strategies it just doesn’t work for,” he says. “There’s no point in trying to do it for a relatively illiquid strategy. Some managers will simply say their strategy doesn’t permit managed accounts. They don’t work for real estate, or private equity, or some derivative strategies.”
Competition is hotting up among administrators to gain market share in the managed accounts business, with technology the key weapon. Ron Tannenbaum, co-founder and managing director of GlobeOp Financial Services, argues that the 10-year-old firm, which has provided services to platform providers since it was launched, has enjoyed a ‘greenfield’ advantage of having created its technological platform from scratch.
“Our largest expense apart from personnel and our largest area of investment every year is technology,” he says. “We’ve built everything across a distributed architecture. Our messaging system for reconciliation produces real-time movement of the data. Without that you couldn’t produce the data fast enough to give the investor a full daily P&L and analysis of reconciliation breaks ready as they arrive every morning.
“Without real-time technology people would be staying way into the night just to look at the reports. For older administrators that haven’t really made the technology investment, it would be an almost insurmountable step to move from where they are now to where they need to be. For many administrators, the barriers to entry to the managed account business are too high.”
Tannenbaum says managed account business has come to GlobeOp through two main avenues. “One is through a portfolio of business from existing large managed account platforms, where GlobeOp becomes the engine inside the governance structure for their own vehicles. The other way is when current fund management clients come to us and say, for example, that they have a private bank that would like to open a managed account. In these cases the investor may be less sophisticated and may ask for very little in the way of extra reporting. However, the investors are comforted knowing that the money is their own rather than being part of a commingled fund.”
According to Thornton, the creation of Altinus has entailed a limited rather than major step-up in infrastructure and resources, given Butterfield Fulcrum’s existing activity in servicing portfolios on other providers’ platforms. “The operations, the daily environment, is our core business, and it doesn’t need a great deal of expansion, although the risk reporting, limit monitoring and guidelines side has required some addition of expertise and tweaks in our technology,” he says. “For areas that we don’t cover ourselves, we’re partnering with other service providers. For example, the platform has protocols around collateral management and FX management, and for their execution we’ve partnered with a well-known cash custodian.”
GlobeOp and Butterfield Fulcrum both use Advent Software’s Geneva portfolio management system. Tom Zdon, vice-president for solution consulting and business development at Advent, says the system is particularly well adapted to the demands of managed accounts because it was originally designed for the alternative space, and this is reflected in a marked step-up in client demand over the past couple of years.
“What’s particularly interesting is the non-traditional hedge fund space, as asset managers look to add alternative products to their existing separately managed account programme,” he says. “We’ve also seen a number of hedge fund manager clients who originally had a fund product and have now gone to a pure separately managed account model. In 2009 a large number of fund of funds managers could only survive by getting closer to their investors, essentially outsourcing their management capacity to these institutions and using their fund of funds platform in a manner not very dissimilar from a managed account product.”
The challenges involved in running managed accounts alongside flagship hedge funds – such as more frequent valuations, managing allocations and distributions between different investment pools or monitoring variations between investment mandates – require automation to avoid running up high levels of cost, Zdon says.
“In the separately managed accounts business, offline Excel spreadsheet practices that used to be acceptable are no longer so. For example, one hedge fund manager we work with reported that a simple request for exposure to a particular issuer was sometime difficult because often all the alternative assets were tracked off spreadsheets and managed by what we called ‘asset class mercenaries’ who had grown up within his firm and allowed it to invest in unlisted assets.
“But once institutional investors are calling you at 4.30 p.m. requesting a full set of reports, you can no longer rely on those off-sheet processes. Today managers are looking to rationalise and centralise all asset classes including underliers into a single portfolio management system that they can access at the click of a button rather than having to accumulate data from multiple systems. Managers that don’t have a system often rely on Excel to reconcile to their third-party administrators, missing key data that could help them justify higher NAVs.”