Private platforms: Why buy the whole car when you can customise the parts?
Despite the decision by CalPERS to divest their hedge fund investments, for the vast majority of institutions they remain a crucial part of their asset allocation. Some of the more sophisticated pension plans are building in-house capabilities to strengthen their expertise in manager selection.
Indeed, as Bruce Keith (pictured), CEO of InfraHedge, an open architecture MAP owned by State Street, comments: “Quite a few of our clients already had existing private managed account platforms but wanted better risk management, better operational oversight.”
InfraHedge, whose assets under management have grown from USD11.45bn in 2013 to USD15.2bn, was launched in 2011 in order to allow institutional investors and allocators to set up private platforms to their own specification and design.
This is helping institutions to focus on manager talent and build tailored hedge fund portfolios in line with specific return profiles, country/sector exposures, liquidity terms, leverage levels and so on. By controlling the assets, the investor is able to mix the right ingredients together to produce the desired level of performance, whilst at the same time outsourcing all the operational, risk monitoring and compliance tasks to the platform provider; hence why these tend to be referred to as infrastructure solutions.
In a recent report by State Street entitled Pension Funds DIY: A Hands-On Future for Asset Owners, one quote in particular stood out. It was made by Richard Brandweiner, CIO at First State Super, one of Australia’s largest superannuation funds.
Brandweiner said: “Can we insource some components of the process and outsource other components? Traditionally, we’ve bought the whole car. Maybe we need to buy the engine or buy the brakes or buy the engineering capability and just build the car ourselves.”
This demonstrates how institutional investors are thinking about customisation.
“I believe that what hedge fund managed accounts provide to investors really hasn’t changed. To some extent it’s the only way to outsource the governance of an unregulated fund to a third party and ensure that there is someone actively monitoring the account on a regular basis,” says Stephane Berthet, Executive Director at Morgan Stanley and head of its FundLogic Alternatives platform, continuing:
“Traditional managed account platforms are under a little bit of pressure because they are more expensive than say UCITS fund platforms, which themselves offer good liquidity and transparency. However, a customised managed account is a more sophisticated business model. Once they have their managed account solution set up, institutions are able to effectively rent the operational infrastructure from the platform provider.
“As it is fully customised they need to have bespoke reporting to address their own idiosyncratic risks and their own needs in terms of capital efficiency treatment; so you have to be very flexible on the delivery mechanism. You cannot be in a position where you just sell funds and tell institutions that is the most efficient way for them to access alternatives; that’s simply no longer the case.”
Keith is encouraged by the fact that whilst clients tend to start with more liquid strategies, the platform is now starting to see investors expand into more complex strategies and move through the liquidity spectrum. “It’s pleasing to see that clients are using managed accounts to access a full range of investment strategies.
“Not only are they moving into credit strategies, asset-backed derivative strategies, we’re also seeing investors stipulate that rather than mirror the flagship fund they are setting out the risk/return that they need from a specific manager. It’s become less about replicating the reference fund and more about using managed accounts to deliver on specific investment objectives and goals.
“The institutional investor is starting to demand more from customisation. This should have a positive impact for manager relationships as they will be delivering solutions rather than products. It is no longer valid to say, ‘This is our reference fund, this is how we do things, and this is the price’,” states Keith.
Back in 2009, ABN AMRO Private Bank approached Lyxor Asset Management to build a dedicated multi-strategy FoHF on the Lyxor MAP. As Marc de Kloe, Head of Alternatives and Funds at the Dutch bank explains: “It helps us on the liquidity side, and with understanding portfolio risk a lot better. Hedge funds are a mysterious beast and understanding how they behave in different market conditions by stress testing portfolios really helps our clients.”
Lyxor was chosen, says de Kloe, because they wanted someone to manage the portfolio. For them, having an asset manager linked to the dedicated mandate was an important consideration when choosing the most suitable platform.
Certain strategies like CTAs have a long history of association with managed accounts. This tends to be based on the classic model where the investor opens an account with their designated bank and gives them power of attorney.
Jerome de Lavenere Lussan is the founder and managing director of Laven Partners, a regulatory compliance and fund due diligence consultancy. Laven Partners reviews managed account agreements that clients have in place at the brokerage to check what limits are in place etc, but this account structure is only the first option.
“The other option is to use one of the platforms. What is a MAP? One still sees a lot of the names from the pre-financial crisis, there haven’t been that many new entrants. Some have disappeared like Alphametrix in the US. I think the MAPs have all generally grown in terms of assets but this is a tough space to crack because of the difficulties to:
• Set up the platform infrastructure;
• Risk management – you need comprehensive IT and risk systems in place;
• Legal set-up costs – made harder because of new distribution rules in the EU.
“In recent times, more people have avoided the bank ‘managed account’ format – usually because of costs or perceived conflicts – and have gone with the fund format on a MAP. The platform is like an umbrella fund of one, where each sub-fund has one client. So managed accounts to me means one investor that sees exactly what assets are held in their name. They either choose to have their own internal risk controls (running an account with their designated broker) or they use a MAP to avail of their risk controls to get a clearer picture of what’s really happening inside the fund,” explains de Lavenere Lussan.
The problem with having a classic managed account is that the investor gets neither an NAV, nor an audit because there are no expenses going through the account as such. That’s why the fund structure format is growing in popularity with private platform providers.
Whilst the main appeal of customisation and outsourcing the infrastructure to a platform is appealing, de Lavenere Lussan urges caution.
“We get sent requests by investors to deconstruct some of the top platforms. Do you really get a better deal by using independent platforms? You get better disclosure but do you really get better cost benefits?
“What clients want when building customised solutions is trust, security, and sound operations. They want to see a top custodian in place, who ideally also works on the administration side for better cost efficiencies. You have to take your time to study what you’re buying. You’ve got to do your due diligence when using managed accounts, and decide on whether it’s best to use the classic account structure with a bank, which means no full reporting or NAV, or use a fund structure. I think a lot of clients are lured in by a false sense of comfort, essentially through marketing and not through an understanding of a platform’s operations,” opines de Lavenere Lussan.
Michael Hart, a veteran of Aberdeen Asset Management, has just joined Amundi’s alternative asset unit as deputy CEO and global head of business development. Discussing the drivers surrounding customisation, Hart notes that as investors generally allocate to more than one hedge fund they are using managed accounts as a toolbox to get an optimal allocation.
This, says Hart, gives the following benefits:
• “They can manage exposure to asset classes: since they have transparency on positions of each managed account, they can aggregate/consolidate these positions and exposures for a more holistic approach of their portfolio of hedge fund managed accounts
• Volatility is something not all investors can “take on”, therefore, using managed accounts and their adjusted leverage levels is also a way to achieve a desired volatility
• Fine tuning between diversification (which may dilute performance) and concentration (idiosyncratic risk of being exposed to blow ups). Since investors benefit from our strong due diligence approach, diminishing the risk of blow up, our investors can focus on a more concentrated portfolio and seek higher returns
• For our Family Offices and FoHFs clients, we have seen an increase in the use of the quantitative model approach that they use for hedge fund selection on their portfolio of hedge funds. They deploy their quantitative approach more aggressively on managed accounts in order to benefit from the liquidity and ability to select good short-term performers.”
One potentially important catalyst for further managed account adoption is Solvency II.
Berthet sees this as an important driver going forward. Morgan Stanley has the solution set and the expertise to help insurance companies overcome the capital cost impact of investing in hedge funds by the way it constructs its managed account mandates.
“Insurance companies tend to be large investors in fixed income and credit. In the current environment, with low yielding returns, it will be difficult to make the necessary returns to keep on top of liability management and deliver a guaranteed return rate of 3 to 4 per cent. If they know that for diversification purposes they need to find extra yield, the idea of adding a hedge fund portfolio on top of their fixed income allocation is driving their decision.
“However, once they decide to invest in alternatives, if they invest in Cayman funds without transparency, they will be charged 49 per cent of capital; this is the Solvency Capital Requirement. With additional transparency, the SCR can be improved, especially for credit and fixed income strategies. However, equity strategies will continue to be penalised. That’s not going to incentivise insurance companies to invest in equity strategies,” says Berthet.
The Catch-22 situation here is that, to Berthet’s earlier point, fixed income isn’t performing well enough.
“If they want to go beyond just investing in credit and fixed income, insurance companies will need to have not just the managed account but also to have efficient access to that managed account and to those equity-related strategies in order to reduce their SCR to 15 to 10 per cent.
“We can achieve this because when we set up the managed account portfolio for the client swaps are used to create both the derivative exposure to the strategies as well as an efficient delivery mechanism.”
Looking ahead into 2015, Keith concludes: “I think the long-term trend is one where institutions want to have greater control over their hedge fund portfolio and how it fits into their wider book. In a low interest rate environment you want to make sure that you’re finding the right mix of managers and performance in order to meet long-term liabilities.”