By Simon Gray – Hedge fund managers may have long been reluctant to provide access to their services through managed accounts, but they are grateful to them now. With total assets in single-manager funds growing steadily past USD2trn, according to HFR, in the process leaving behind the previous high water mark from the second quarter of 2008, managed accounts represent a growing proportion of capital invested in the industry, even if assessing the precise level is a somewhat inexact science.
A much-quoted survey of the US hedge fund industry by capital markets research and consulting firm Tabb Group, published in November 2009, predicted that the volume of assets invested through managed accounts would rise from USD468bn that year to USD790bn in 2011.
Rating agency Moody’s Investor Services, which in May last year quoted considerably more modest estimates of USD41bn, just 2 per cent of total hedge fund assets, held by the top 10 platforms, remains circumspect in its most recent review of the industry, published in March. Moody’s notes that while managed accounts (along with Ucits vehicles) remain “popular modes of investment, neither product segment has grown materially as a proportion of the overall hedge fund universe”.
While managed accounts remain attractive particularly to very large and conservative investors, and continue to be aggressively sold by platforms, the report argues that the pace of asset growth among major managed accounts platforms has trailed that of the hedge fund industry as a whole.
“In 2010, several large institutional investors announced that they would be investing in managed accounts offered through large platforms, rather than investing directly in hedge funds,” Moody’s says. “Although managed accounts represent a fraction of the total hedge fund industry, this is a trend set to continue in the short term given perceived advantages such as independence, transparency and liquidity.
“However, the proliferation of managed accounts as a major mode of investment in hedge funds also poses a number of risks, such as concentrating operational risks into fewer counterparties (in the case of the large platforms), increasing the expense of managing investments and causing further fragmentation in the hedge fund industry.”
Nevertheless, the development of managed accounts as a vector for alternative investments offers significant possibilities for service providers, according to Alternative Managed Accounts: Opportunities in Fund Administration, a recent white paper published by Advent Software and Maples Finance (now Maples Fund Services).
The report argues that few institutional investors have the capability and resources to administer a multiple-manager account platform themselves, and that “administrators that can successfully leverage their infrastructure and adapt their skills to the needs of institutions will have the opportunity to expand their business into a whole new market beyond hedge funds”.
The authors note that many administrators already have the operational building blocks in place, combined with accounting expertise and experience in working with multiple managers, to administer managed account platforms for investors. However, they caution that launching a platform is “a formidable undertaking” and firms must decide whether the opportunity makes sense economically, justifying a commitment of substantial resources.
Investors are not limited to an up-or-down choice between managed accounts and pooled fund investment, but have a range of options, according to Gabriel Bousbib, chief executive of Gottex Solutions Services, the managed account platform established by Swiss-based fund of funds specialist Gottex Fund Management.
“The managed account sector continues to provide an important element of hedge fund investing,” he says. “However, we have long said that they are not a panacea, just one piece of the puzzle. There are different structures, different levels of managed accounts, and different levels of services. We have always approached the topic of managed accounts as one important element that provides hedge fund investors with more options.”
According to the Advent-Maples white paper, the crucial moment for the managed account sector came in 2008 when institutions that had been steadily committing an increasing proportion of their portfolios to hedge funds suddenly found themselves unable to redeem their investments as managers responded to investors rushing together for the door by imposing gates and other redemption restrictions.
“Hedge fund investors came to realise how interdependent they had become with each other as part of commingled vehicles,” the report says. “For example, if a critical mass of investors suddenly decided to reduce their holdings within a fund, some managers needed to exit positions prematurely to provide liquidity for redemptions, jeopardising less-liquid strategies and adversely impacting overall fund performance for remaining investors.
“Having to answer to their own constituencies and governing boards, institutional investors sought a way to access hedge fund strategies without incurring the operational and liquidity risks that made the funds so vulnerable to market volatility. The solution: managed accounts, run by experienced hedge fund managers pursuing alternative investment strategies.”
Managers may not necessarily have wanted to embrace managed accounts but felt that if they did not do so capital might well go elsewhere – at a moment when for the first time in years, even the biggest and most prestigious managers were looking to rebuild their assets under management following the performance losses and investor redemptions in 2008 and 2009. They perhaps also recognised that the alternative investment industry was only following in the footsteps of the more mature long-only sector, where segregated mandates have long been a well-established route for institutional money.
One of the chief beneficiaries of this trend has been the growing number of managed account platforms, where the provider takes on operational control of the assets from the hedge fund manager and delivers or contracts other services such as administration and risk management. Investors benefit from the liquidity offered by the platform provider but their capital is commingled, as it would be with direct investment in a pooled fund.
An important advantage of the platform approach is that it allows investors to benefit from the best practices instituted by the provider, according to Stefan Keller, head of managed account platform research and external relations at Lyxor Asset Management, whose platform is the industry’s biggest at more than USD11bn in assets under management.
“The investors have access to state-of-the-art risk management techniques, for example,” he says. “This is already part of our model, but it will soon be a requirement for the industry in Europe once the AIFM Directive has come into force in 2013. At Lyxor we have gone through all the funds that are on our platform as managed accounts and we know our approach already meets the directive’s requirements in areas such as liquidity management and stress-testing requirements. This offers more security for the investor.”
More difficult for institutions to undertake alone is the single-investor managed account approach, where the investor must oversee accounts run by multiple managers. “Few institutions have the operational infrastructure to deal with the complexity of aggregating data in different formats from multiple managers, [and] the legal or accounting expertise to value multiple investment vehicles properly,” the Advent-Maples report says.
All but the very largest institutions will need help from an external administrator to manage the myriad processes involved: “Each investment vehicle is a separate legal entity with its own rules, terms and mandate. The managers will likely have different formats for trade files. They will be trading different types of securities and in different currencies. The investor has to track its capital commitments to each manager.”
But the challenges, both technological and economic, are almost as daunting for the administrator, according to the paper’s authors. “The biggest challenge is the level of custom integration required – and the resulting cost – to exchange data with multiple managers,” they say. “Putting the right kind of infrastructure and flexible processes in place at a price point that makes sense is difficult to figure out.
“When a firm is the administrator for, say, a USD2bn hedge fund, the revenues justify the investment of time and resources to build the interface necessary to service the fund. Building 10 such integration points to process accounts of USD100m each on behalf of an investor is another matter. You need to determine not only whether your existing infrastructure is up to the technological challenge, but also whether the investment required is likely to pay off economically.”
The biggest information technology challenge facing administrators is integration, according to Tyler Kim, chief information officer for Maples Fund Services. “You have managers that are transacting daily and expect response files in the format they use for the operation of their flagship fund,” he says. “The second major IT challenge is compiling all the reporting from the managers into a format that enables the investors to understand what’s happening. For the benefit of investors, Maples has developed a managed accounts dashboard that rolls up all the information from our systems.”
The administrator may also be involved in other functions that in traditional investment arrangements are taken care of by the fund manager, but now fall to the investing institution. “They need proper legal counsel on fund formation, structuring, domiciling and governance,” the report says. “They may well look to administrators for guidance on matters where they lack experience, such as offshore funds.
“Investors will also want to consider some sort of oversight independent of both the investor and the platform to keep tabs on managers and further manage risks. Administrators must be able to account for a wide variety of different legal entities with different structures, rules, restrictions and governance.”
The report concludes: “This adds up to a big opportunity for fund administrators, not only to capture more assets under administration, but also to engage directly with investors and grow their client base beyond their traditional hedge fund clientele.
“To capitalise on the opportunity, however, administrators will need to adapt to a model that is the opposite of the hedge fund model – one investor, multiple managers. They will need to meet exacting requirements for consolidated reporting, position-level transparency and analytics capabilities. And they will need the robust technology infrastructure and integration capabilities to handle the complexity that a managed account platform entails.”
Please click here to download a copy of the Hedgeweek Special Report: Hedge Fund Managed Accounts May 2011
