By Andrew Lapkin – Institutional investors are increasingly shifting their hedge fund investments from traditional, commingled structures to Dedicated Managed Accounts (DMAs). A DMA is a customised single investor hedge fund with portfolio assets ultimately owned (and controlled) by the investor. One of the most attractive benefits of DMAs is the opportunity to utilise the DMA structure to achieve “structural alpha”. Structural alpha is the ability to enhance returns by taking advantage of the unique structural aspects of a DMA. There are several ways that investors achieve structural alpha through a DMA structure.
A DMA is a separate vehicle and can often have key differences from the manager’s commingled fund, such as differences in investment strategy and investment guidelines. In addition, a DMA substantially reduces the operational burden of the manager which can help justify a lower management fee. The use of a DMA structure combined with a significantly sized investment can and often does allow the investor to achieve a material discount from the manager’s standard fees. DMAs also allow the investor to design custom fee structures such as fixed or flat management fees, incentive fee hurdles and performance claw-backs. DMA investors can generate significant cost savings from both reduced and custom fee structures.
A DMA allows an investor to potentially lower fund expenses by selecting platform level service providers (eg administrator, auditor, etc) and using its aggregate assets to achieve economies of scale through platform pricing. Similarly, some investors consolidate the prime brokerage business done across their DMA platforms with one or two prime brokers to obtain more favourable, platform level financing and commission rates. In addition, DMAs create the opportunity to lower fund expenses by prohibiting or limiting the manager from passing through manager level expenses to the investor’s DMA.
DMA investors have increased flexibility to lever their investments. The DMA investor can elect to fund only the necessary margin in addition to a reasonable cash buffer in order to obtain the desired investment exposure. Certain hedge fund strategies such as managed futures strategies are inherently cash rich and allow the investor to maximise the benefits of notional funding. The excess cash is controlled by the investor and can be deployed towards other investments to obtain an additional return. The investor can use the excess cash to obtain an enhanced return which delivers cost savings when compared to a similar investment in the manager’s commingled fund.
Unlike commingled hedge funds, DMAs provide investors with daily position-level transparency. DMAs allow investors to monitor and analyse daily performance, performance attribution and risk exposure. The availability of this “actionable data” can drastically improve an investor’s investment and risk management. In addition, the transparency available through DMA structures may give investors the confidence to build more concentrated portfolios rather than mute returns by over-diversifying as a risk management approach.
DMA structures offer a variety of ways for investors to achieve “structural alpha” and thereby, the ability to enhance their hedge fund returns. These incremental increases in returns can be quite impactful as they compound every year for the life of the investment. The ability to increase annual returns is the reason that “structural alpha” is one of the key drivers fuelling the increase in DMA adoption by institutional hedge fund investors.
