With market volatility always top of investors’ minds, the ability to assume greater control over a particular investment strategy using a managed account structure has grown in significance in the last few years. With markets due a correction, and investors keen to optimise the way they allocate to hedge fund strategies, taking a customised approach – as opposed to necessarily using commingled managed account platforms or `public’ platforms – continues to resonate.
This is playing to the strengths of dedicated platform operators, with the infrastructure expertise needed to meet individual client demands.
A custom mandate enables investors to build out a portfolio that gives exposure to the best aspects of a manager’s strategy, rather than the strategy as a whole. This is customisation at its best; stripping out X per cent of a strategy’s exposure to certain securities and keeping the rest.
One carve-out option, for example, could be to build a mandate that only has exposure to a manager’s top 10 or 20 investment ideas.
Another benefit of the managed account structure is that it allows investors who would not ordinarily invest in hedge funds gain exposure to managers in a more controlled and transparent fashion. The managed account is a more expensive option, but the upside is that investors get far greater insights into the make-up of the portfolio, rotating in and out of strategies as and when necessary.
Customise carefully
Achieving customisation in a dedicated platform solution, however, requires careful consideration by an institutional investor.
“Overall, I would say a large number of MAPs in the marketplace have become a lot more institutionalised and the service offering has become a bit more standardised,” comments Sam Thompson, head of the managed account platform business at Man FRM. “It used to vary across different platform providers but we’ve seen a general trend whereby, as the industry has matured, there has been a more consistent delivery of traditional managed account services.
“As we see increasing demand from investors to customise their hedge fund exposure, one of our core strengths is that as an allocator ourselves, we can offer a lot of add-on services to help institutions implement their hedge fund programme.”
Part of that value-add service, at least from Man FRM’s perspective, involves leveraging off of an extensive risk and investment team, both within FRM as well as the wider Man Group.
“For example, we’ve developed in-house a range of risk premia strategies with the AHL team and Numeric – two of our quantitative investment businesses. We feel the best client mandates that we have are ones where we work most collaboratively with the end client,” says Thompson.
If the nuts and bolts are all the same, what other elements around the edges does a platform offer to help implement an investor’s hedge fund allocation programme? The value-add services that Thompson alludes to might include manager selection, identifying investment ideas, helping manage portfolio exposures, etc.
“That’s what will set MAPs apart, going forward, and that’s what we remain focused on,” he says.
Taking a creative approach to fee structuring is particularly relevant. Not that platforms should attempt to second guess the managers they are working with. Ultimately, it is the investor that is looking to work with the manager to reach an agreement, when it comes to accessing specific parts of their investment strategy in a cost-efficient way.
As Thompson says: “It’s about making sure investors know what types of fees they should be paying for the exposure they are taking. Whereas commingled funds take a more blended to approach to fees (to satisfy all investors), in a custom mandate the investor has more flexibility. The manager might agree to lower fees for more liquid sleeves of their portfolio, and higher fees for more capacity-constrained, illiquid sleeves.”
Turn the risk dial
In today’s low rate low return environment, having the ability to control how much risk one puts into an investment strategy is a substantial benefit; after all, it is the investor who controls the mandate; the manager is simply hired to execute on it.
“That is one of the significant benefits of our Dedicated Managed Account (DMA) solution,” says David Young, President of Gemini Alt. “People might want different amounts of leverage in the carve-out strategy. A client we are currently onboarding is just one example of the demand for customisation today. I don’t think it’s that uncommon. I wouldn’t say it’s as much as 50 per cent of our business but we do get a lot of requests for DMA solutions.”
“The ability to alter the amount of risk provided by individual managers is probably the most frequent request we receive related to custom mandates,” adds Edward Lund, SVP Business Development, NorthStar Financial Services Group, LLC.
Manos Chatiras is Head of Multi Asset Products at Deutsche Bank. He says one example of customisation work this year was for an institutional client looking for a bespoke regulated vehicle investing in liquid alternatives.
“The investor wanted to achieve a diverse portfolio utilising the full universe of liquid alternatives, including more esoteric strategies as well as alternative risk premia, with the ability to monitor and manage capital ratios for the portfolio to meet their regulatory needs.
“Deutsche Bank built a customised solution which included investments in bespoke strategies designed exclusively for the mandate, as well as investments in a number of our existing liquid alternatives strategies. The solution also provides customised risk and position-level reporting to the investor and their hedge fund advisor to facilitate capital ratio monitoring and management,” outlines Chatiras.
Another benefit to having a customised platform is the infrastructure support that comes with it. Rather than focus on the costs of hiring internal staff, an investor outsources everything to the platform operator.
“The cost involved to building one’s own MAP infrastructure is significant,” says Young. “You need systems in place and people in place to run them. When you’re allocating to any hedge fund strategy, it’s not just the reconciliation of the data, it’s also reporting on that data.”
The CIOs of pension plans or endowments are often burdened with spending significant time on operational services. Using a platform provider, says Lund, “is a way for them to alleviate these burdens by using a standardised process, allowing them to focus on investment decisions”.
Scientific precision
Sigma Analysis & Management delivers turnkey infrastructure solutions for institutional investors. Boasting a team of quantitative specialists with academic backgrounds in physics, mathematics and computer science, Sigma’s value-add is the sheer processing and analytical power it brings to bear when looking at performance attribution and risk exposure in clients’ portfolios.
“We have programmers and trained physicists on staff with the expertise to build software that we use to deep dive into portfolios to determine style drift and alpha decay, as opposed to just doing correlation analysis,” comments Michael Rudd, Senior Director of Investments.
“We go a step further to really determine what the drivers of returns are and offer unique solutions to augment returns for clients. Our mission is to provide investors the tools to maximise the extraction of alpha from our custom managed account solutions, whether it is through enhanced portfolio monitoring, capital efficiency, or fee realignment.”
Show me the alpha
Customisation has the ability to improve the investor’s hedge fund experience, which ties in closely to the one issue that always seems top of mind: fees.
Provided the investor can see without ambiguity that the manager’s strategy – be it a carve-out or not – is working such that the returns are mostly alpha, and not mostly market beta, they are happy to pay performance fees; by they 20 per cent, 17.5 per cent; whatever the agreement.
“We hear more and more from investors that they are perfectly happy to pay for alpha but are left frustrated when they find themselves investing in a product where the manager isn’t able to clearly explain where the returns came from, in terms of beta or alpha,” comments Andrew Biggs, Director of Portfolio Analytics at Sigma.
“In 2017, that’s frustrating when rates are low and access to market beta is extremely cheap. The markets have gone north the last few years. So for a sophisticated institutional investor, they want to look for the ability to disentangle beta from alpha and are willing to pay for alpha.
“We take that very seriously and view it as a call to action. We have our own fee lab where we can go through any number of iterations of fee structures. We spend a lot of time looking at factors for return attribution analysis – if a fund says it is doing X, but really it is only doing 0.75 X and 0.25 Y, is that what you, the investor, think you are paying for?
“Technology allows us to do a lot of sophisticated analysis on a portfolio to determine where those returns are coming from,” adds Biggs.
This is a vital consideration when partnering with a managed account platform provider. Control is the optimal word when using managed accounts. The more control one can gain by getting clear insights into a strategy’s performance, the stronger position the investor will be in to further negotiate on fees and ensure that their interests are aligned with those of the manager.
Technology developments have really pushed the dialogue forward in this respect.
Engineering excellence
“We are mindful in constantly working towards improving every single component of our platform, including our relationships with counterparties, in order to provide clients with a high-quality investment experience. Our approach is highly customisable. The degree of flexibility we can deliver to large asset allocators ensures our solutions are adaptable to their evolving reality. This is one of the main reasons why Innocap is selected as platform provider.
“Over time, we have built strong partnerships with some of the largest public pensions worldwide, which have given us a privileged view of both market trends and best practices,” comments Jonathan Planté, Manager, Business Development & Investor Relations, Innocap.
Because of its capacity to tailor managed account to allocators’ needs, Innocap is agnostic to the types of strategies to be on boarded on its platform. As Planté says: “We don’t focus on the denomination of a specific strategy but on the instruments to be traded.”
He continues: “We have experience in very illiquid assets. We are often asked if we have the capacity to deal with private equity strategies. If you think about it, the typical private equity fund is a buy and hold strategy implemented with OTC stocks. It’s not anymore complex for us than other instruments we are currently dealing with, such as non-performing loans, distressed or physical commodity.”
Caveat emptor
For all of the customisation benefits of a private platform, from granular analytics on performance and risk to carve-out options, creative fee structures and the ability to widen out the mandate to illiquid strategies with the same level of control and transparency, there are still risks involved.
Not all managed account platforms are necessarily created equal and there are some in the industry who feel much more investor education needs to be done. Especially for those who wish to have a dedicated platform.
One of those is Joshua Kestler, President and COO of HedgeMark. In his view, most of the top 10 platforms in the market offer totally different underlying services.
“How do we as an industry come up with a best practice model that investors use as the standard service offering necessary for operating a managed account platform? Right now it’s all over the place.
“Some platforms offer more of an investment solution, some just provide data and risk aggregation technology, and others are offering a funds-of-one solution, which means the manager maintains primary control over operations rather than the platform. Unfortunately, the industry has done a very poor job at educating investors about what they need and what they should be looking for in a managed account provider,” argues Kestler.
Even when the client has created a private platform, and is the sole investor, there can often be too much reliance on the underlying manager. This is not what a custom MAP is meant for.
“The role of the manager really has to be restricted to trading the portfolio,” asserts Andrew Lapkin, CEO of HedgeMark. “They shouldn’t be involved in pricing, they shouldn’t be moving cash. So many investors and platforms still end up delegating operational functions to the manager, which severely diminishes the control benefit of having a managed account. We believe that the number of platform providers that offer a suite of services which allow investors a true private managed account platform is still quite small.”
Planté says that some MAPs are operated by service providers who do not necessarily do all the work internally. As a result, the full costs of using the platform are not fully known. “What does the investor have to pay for the vehicle, for the reporting? It is important to assess the costs based on what the client’s platform will need, and the service providers it is going to use,” states Planté.
“The best advice I can give to an investor is spend as much time as possible evaluating the differences between platforms, try to define what is important to you, and then make sure the platform you choose is able to deliver the required services.
“The last thing an investor wants is to be overburdened because the platform they choose requires the use of unexpected internal or external resources, or because they’re not getting what they thought they were paying for. We see that as a real issue going forward, as a result of lack of investor education,” concludes Kestler.
