Co-investments & conviction trades: evolving investor trends in managed accounts
BNY Mellon HedgeMark is a dedicated managed account provider, solely focused on creating and operating managed account platforms for institutional investors. Launched in 2012, the business today has more than USD23 billion in assets across more than 100 funds spanning a broad range of hedge fund strategy types, including long/short equity, macro, equity market neutral, credit, CTAs, risk premia and more.
Large institutions have gradually moved away from off-the-rack, one-size-fits-all products and shifted towards strategies more tailored to their particular investment objectives, says Joshua Kestler, head of the business in New York.
Co-investments are a key area that is gathering momentum, which Kestler believes has enhanced the managed account sector’s offering, drawing in those investors who are keen to tap into specific investment themes or trades.
“We have seen an increase in investors using managed account structures to implement co-investments over the last 12 months. Here, a manager may have a lot of conviction in a particular trade – it could be almost anything from an opportunistic equity trade to a long-term position, or a distressed-type trade – and the end client wants to either size up that trade, or directly participate in a specific idea. The trade is then deployed in a managed account that is under the investor’s control.”
He continues: “We have a few clients who have co-investment vehicles and all have relationships with multiple managers who may see an opportunity in the market that needs to be put on and implemented quickly. They are able to implement these ideas in a relatively fast and expedient manner through the managed account.”
Elsewhere, Kestler points to a range of components – the types of investment vehicle, the degree of transparency, the structure of fees and the range of service providers – that are increasingly tailor-made to clients’ demands.
“The managed account structure has created an option for the investor to truly customise the investment experience to their specifications,” he explains.
Recent growth has been spurred by an increased demand among investors for greater customisation, a trend that has been duly seized upon by managed account platforms with relish in the past 18 months.
As well as the ability to customise structures and investment strategies, increased customisation – and, ultimately, lowering – of both management and performance fees is a common thread driving managed account investing.
“We’re in an environment where everyone in the industry is looking to reduce manager fees. There’s long been a feeling that hedge fund fees have been too high, and there’s been a desire to create a custom structure that better aligns the interests of the investor with the manager,” Kestler explains.
Delving deeper, how are the various motivations and goals of different investor types evolving when it comes to their approach to managed accounts? For large pension fund investors, economics continue to be a primary concern, along with matters of control. Elsewhere, transparency and customisation are becoming major themes among fund-of-funds businesses.
He points to one pension fund client that successfully saved USD 60 million per year in fees by renegotiating with their managers and moving its allocation over to a managed account model. “It’s a huge driver – economics is a big piece.”
He continues: “Fund-of-funds businesses tend to be greater users of transparency and data. They tend to have larger investment teams who can dedicate the resources to focusing on the data and have much more regular and informed conversations with their managers on a daily basis because of the transparency.
“When it comes to clients transitioning to a managed account model, it’s typically an evolutionary process. It is something that happens over time. Clients often start by dipping their toe in the water with a couple of managed accounts to make sure they are comfortable with the process while learning to effectively use the transparency. Once clients get comfortable with the structure, they grow their platforms more rapidly over time.”
On control, situations such as the Bernie Madoff scandal and fears over redemption suspension loom large among pension fund boards. “For the pension industry, having control over their own vehicle and assets really helps check all the boxes for investment committees and boards of pension plans. The ability to mitigate fraud and other major reputational risks are a big motivator for pension plans.”
Managed accounts have also helped provide comfort to allocators concerned about managers stepping outside their investment mandate.
“For every fund on our platform there are investment guidelines applied to the managed account. These guidelines are a set of rules that the client contractually agrees with the manager – in terms of which instruments are permitted, the amount of permissible leverage as well as other exposures, amongst other restrictions. These are the parameters pursuant to which the manager is required to trade the portfolio.” He says.
“We monitor compliance with these guidelines every day. In one instance, we found that a manager traded Bitcoin – which was not on the list of permitted instruments. Our client confirmed that it did not want Bitcoin exposure in the portfolio and, therefore, the manager was required to promptly liquidate that trade.
“If the client had been in the commingled fund, they would have had Bitcoin exposure and been none the wiser. But the transparency and oversight we provide prevented an unwanted exposure.”
While fees have been the subject of a protracted wrangle between investors and managers, one area less frequently explored is expenses. Says Kestler: “Investors often think about fees but they don’t think about the expense side. There can often be many different expenses that investors are getting hit with – managed accounts are one way to limit and prevent unwanted expenses.”
He adds: “We’ve had several instances where managers have attempted to send an invoice through to the fund relating to an expense that was not contractually permitted to be passed through to the managed account. Unlike commingled funds where the hedge fund manager typically has extremely wide leeway in their documents to pass through all kinds of expenses to the fund, in the context of a managed account, managers are generally prohibited from passing expenses through to the fund without the approval of the client.”
Turning to potential challenges further down the line, Kestler expects the managed account model to remain resilient as a way of investing and getting exposure to hedge funds, regardless of industry performance.
“I don’t really see too many hurdles to continued growth in the managed account space. I think our niche industry has been generally immune to performance challenges in the broader hedge fund industry,” he says. “Many institutional investors believe that managed accounts are a superior way of accessing the asset class particularly if you’re someone that allocates large dollar amounts.”
He continues: “It’s less about people putting new money into the space and more about them changing the way that they invest their existing allocation. This structural transition has helped our industry have a certain level of immunity from any kind of performance issues.”
That said, Kestler is keen to stress the importance of positive performance. “2019 was actually a pretty good year for hedge fund performance. Unfortunately, hedge fund performance tends to be compared to t S&P returns, particularly during a bull market. While this comparison is common, it is flawed and misplaced.”
Building on this point, he suggests there remains a need to continue to educate investors about the appropriate role of, and the reasons for having, hedge funds within a broader investment portfolio.
“We would all love for the equity markets to go up forever, but inevitably at some point things will turn – and that’s often when hedge funds play their strongest role,” he remarks. “Broadly, hedge funds are meant to provide risk-adjusted returns with lower volatility and less correlation to the broader markets.”
Andrew Lapkin is responsible for the overall management at HedgeMark. Prior to joining HedgeMark in 2011, Andrew was the Co-Founder, President and Chief Operating Officer of Measurisk. While at Measurisk, he was instrumental in the development and oversight of the company’s core risk management offerings and worked with more than 1,000 hedge funds representing over USD650 billion in assets, including 75 of the world’s largest 100 funds. Andrew received an MBA in Finance and Management from Columbia University and a BA in Economics from Lafayette College.
President & Chief Operating Officer, HedgeMark
Joshua Kestler is responsible for all matters relating to HedgeMark’s Dedicated Managed Account platform including development and implementation of business strategy and oversight of the structuring, onboarding, accounting, operations and business development teams. Prior to joining HedgeMark in 2012, Joshua was Head of Managed Account Platform Operations for Deutsche Bank’s X-Markets Hedge Fund Platform in the US where he was responsible for fund structuring, manager onboarding, operations and managing counterparty relationships. He received a JD cum laude, from the University of Pennsylvania Law School and a BA summa cum laude, from Rutgers College.