There are a number of different reasons for why investors wish to allocate to emerging managers. They might be looking for more performance from emerging managers because they are less constrained by overcrowded trades in the markets, or simply wish to gain exposure to more interesting, niche strategies that few others are looking at. Whatever the reasons, using separately managed accounts are one of the most effective tools for institutional investors. And a way to break free of the shackles of investing purely in blue chip names.
If large institutions concentrate too many of their assets among the same universe of say the top 100 largest hedge fund managers, and returns aren’t great, it adds to the pressure of why they invest in hedge funds at all, adding fuel to the fire of negative perception that exists among political parties and the wider media.
Of course, the minute an institution uses a dedicated managed account it renders the `Why are you investing in a hedge fund?’ argument obsolete: all that matters here is the investment strategy. A hedge fund is just the legal structure wrapped around it. Access to the manager’s adroit stock picking skills or global macro expertise: that’s all an investor cares about.
In that sense, it also renders irrelevant the size of AUM the manager is running. But, importantly, in this low rate environment, investors want the confidence to go out and invest in the next best emerging manager(s), and in a way that avoids commingled risk and concentration risk.
Ticking the boxes
Finding managers that might be young (in terms of track record) and small in AUM terms can give institutions a chance to really diversify away from their peers.
And in that regard, the managed account structure ticks all the boxes.
“We are having discussions with a large institution who wants to optimise its allocation to emerging managers,” confirms Eric Bissonnier, CIO, Alternative Solutions, LumX Asset Management. “They don’t have to be dependent on what might be a small infrastructure that the manager is running. They can put that to one side; all they want is to access the manager’s trading skills. The time to market to do this is very quick, once the investor has set up the platform structure.
“We have also had discussions with emerging managers who have come to us to discuss joining our platform but we haven’t implemented anything yet.”
As Bissonnier rightly states, if you can solve the transparency and risk monitoring issue for one hedge fund, you can solve it for pretty much any hedge fund (established or emerging). This has a lot of value. “With regulatory requirements as they are, and reporting obligations being extended, you can’t just hide behind the complexity. You have to solve that complexity, and a managed account platform inherently achieves this,” he adds.
Regulated funds provide even more reassurance
The ability to access emerging managers in a managed account needn’t be reserved to those wishing to have dedicated mandates. Commingled platforms, such as those operated by Lyxor Asset Management and Gemini Alt, provide just as much control and transparency on the underlying manager(s), giving investors a managed account experience and the reassurances that there will be no undue operational risk.
Lyxor has pushed the innovation envelope recently, focusing on building out the Lyxor Alternative UCITS Platform to give access to managers (both established and new challengers) in a regulated fund format. There are currently 10 single-manager UCITS on the platform, with a further 10 scheduled to be added over the next year or two.
“We’ve been doing this since 1998,” says Daniele Spada, Head of Lyxor MAP. “Our model and the way we help our investors has evolved with their needs over time. We provide a lot of services to our investors in addition to the products we offer. We are able to help institutional investors do whatever they need from research, selection, advisory to infrastructure services, in order to help them with fund investments across different asset classes; everything is in compliance with their risk management policies and in line with what their investment committee is looking for. Every time there is a market dislocation, we help them understand what the risks are and if they need to take action.”
That is especially important within an emerging manager context. Even if the manager has a blip, and their strategy goes through a down period, managed account investors are insulated from the risks of other investors potentially redeeming en mass, in the offshore fund, in turn eroding performance gains.
“We really help investors from A to Z. We have structured the platform in a modular way so that they can pick the products or services they need to build their investment solution,” adds Spada.
Lyxor sees itself as much more than a fund selection platform. It is, says Spada, a fully integrated centre of expertise, offering different types of strategy (offshore funds, Alt UCITS, traditional long-only funds) under a single roof. First, its fund analysts advise clients on the benefits of switching from one type to another.
“Second, our technological capabilities mean clients have access via our website to the latest performance and risk analytics. Third, our fund analysts can help clients analyse the sources of performance and can advise, for example, whether they are better off in a multi-strategy fund or in separate individual strategies.
“Fourth, our buying power helps us negotiate competitive fees for investors. Fifth, we incentivise top fund managers to offer their strategies in an Alt UCITS format as they know we can help them access clients. In summary, the platform gives clients access to different types of fund but it’s also a research, advice, reporting and client servicing centre,” explains Spada.
Operational risk is not a risk premia
One could argue that irrespective of the size of the manager there will always be some degree of enterprise operational risk. Such is the depth and variety of hedge fund managers that a five-person quantitative fund could well have a more advanced IT infrastructure than a 50-person equity long/short fund. What a MAP allows the investor to do, says David Young, President of Gemini Alternative Funds, LLC (`Gemini Alt’), is remove operational risk concerns from their overall risk analysis of a manager.
“They can analyse managers based purely on the investment thesis and how they employ that thesis to generate returns. That is a huge plus, not just for young emerging managers, but small established managers. I’ve seen situations where asset allocators won’t talk to anyone with less than USD500 million in AUM; there are an awful lot of high quality fund managers operating below that threshold,” comments Young.
Some in the industry believe it is not only beneficial to use managed account structures to access emerging managers; it is a necessity.
Jonathan Planté is Manager, Business Development & Investor Relations, Innocap. He says an institutional investor’s business is not to take operational risk.
“Operational risk is not a risk premia for which allocators are going to be compensated. By investing through a managed account, allocators remove most operational risk from their balance sheet. For this reason, MAPs are quite appealing for allocators seeking exposure to emerging managers. It enables their access to specific investment alpha while benefiting from structuring and operating alpha. In the recent years, we have launched emerging manager programs with various clients. This activity is something we are continuing to focus on as we believe it to be a great growth factor for our company,” explains Planté.
The institutional governance framework offered by well-established managed account platforms can be important for emerging managers, as some of them may not have the scale or resources for institutional infrastructure.
Expanding on the point made above by Planté regarding operational risk, Manos Chatiras, Head of Multi Asset Products at Deutsche Bank, offers a bank platform perspective. He says that many of Deutsche Bank’s institutional partners want to invest in emerging managers “but are only willing to do so through our managed account framework, precisely to mitigate any potential operational risk. The set-up benefits managers as well as investors – emerging managers can gain knowledge and experience while working with Deutsche Bank.”
One could argue that the managed account structure in a way frees the mind of the institution. For too long, allocations have gone to the top 100 hedge fund managers, largely to protect reputations and follow the herd. Why risk investing in a manager with a 1- or 2-year track record, even if he is posting impressive uncorrelated returns?
A managed account frees the shackles. It gives investors the confidence to strike out and access the best, most exciting trading strategies. They don’t have to worry about what the manager’s fund looks like, what their pricing policy is, how much AUM they have. Any risk is transferred from the fund to the platform itself.
An effective marketing tool
Moreover, as more large hedge funds hard close due to capacity constraints they don’t need to offer managed accounts whereas emerging managers are far more willing to do so. After all, many of them are still in asset gathering mode.
“It removes much of the operational due diligence focus that investors would otherwise have on those managers,” says Andrew Lapkin, CEO of HedgeMark. “Because of the transparency and the investment guideline controls that can come along with a managed account, investors may have more confidence in making an investment in an emerging manager if they determine that the platform has the proper controls and oversight in place.
“We’ve had discussions with a few emerging managers about working with them to deliver managed account solutions. Investors are likely to see a benefit from having a managed account solution with BNY Mellon providing the infrastructure behind it. This approach may help emerging managers overcome one of the hurdles of capital raising.”
Both the investment guidelines and daily monitoring are critical when investing with an emerging manager. It is another way the managed account really opens up a set of investment opportunities that otherwise wouldn’t exist.
Joshua Kestler, President and COO of HedgeMark, is enthusiastic when asked about the level of interest HedgeMark is seeing with respect to accessing unknown names.
“We are seeing a number of our clients branch out to make investments with smaller and emerging managers who have they believe have attractive return profiles. One client has their own dedicated emerging manager platform and another client is currently in the process of creating one.
“There can be investment value in accessing these managers, but in a controlled way. I think managed account structures are a great way to revive the market for early stage managers and for large allocators to get comfortable giving them capital,” states Kestler in conclusion.