For some, hedge funds have become dirty words over the last year, given Lehman Brothers’ collapse and Bernie Madoff’s fraud.
This poses something of a quandary for trustees: on the one hand, governance expectations and having your fingers burnt in 2008/2009 means you may not want to invest in hedge funds again; on the other, the anticipated returns of hedge fund portfolios are too good to sideline altogether.
Enter managed accounts – an investment vehicle that rewards you with hedge fund-like returns, but with greater flexibility and more transparency. So are they all they’re cracked up to be?
Broadly, there are two ways to access a managed account, or MAC: through a managed account platform (MAP) or proprietary management accounts (PMA). The first offers multiple investors direct access to MACs, which are essentially investment vehicles administered by a platform provider that appoints an asset manager to look after the assets. The manager’s role is limited to trade selection and execution; it is the platform provider that retains control of the assets.
With PMAs, an investor or overall manager invests in a MAC by tailoring a hedge fund manager’s assets to suit their objectives – the manager retains overall control and the duties of the hedge fund manager are limited to building and managing the portfolio. As with any investment structure, how they are designed is crucial, and if they are operated poorly, all the benefits can be wiped out.
Richard Tomlinson, managing director at Tomlinson Investment Consulting, says he had witnessed a spike in interest on a global level in these strategies over the last year. “The events of the last 18 months has led to a fairly drastic rethinking of priorities. Investors are far more concerned now about transparency, liquidity and governance than they were two or three years ago.”
Paul Dackombe, head of institutional UK sales at Man Investments, was among the first to admit that the near collapse of credit markets alongside a slew of other market events had a broad impact on hedge funds in 2008.
“The pronounced sell-off across all markets caused sizeable redemptions in hedge funds. That, combined with market illiquidity, caused a number of funds to gate or suspend redemption, which understandably caused concern and frustration for investors who needed to redeem,” he says.
“As a result, investors are no longer solely concerned with past performance and fee structures. Instead, they are paying more attention to portfolio transparency and control of assets to avoid a scenario where they cannot redeem.”
Under a MAC structure, problems like liquidity would be easier to solve. In the event of liquidity problems, it is the sponsor (eg the platform provider or the PMA manager), and not the hedge fund manager, who has operational and risk control over the assets, and they decide whether gates or suspensions should apply.
Other benefits include greater control over the assets, favourable liquidity terms compared to direct hedge fund investment, and greater transparency, since the MAC sponsors have direct daily access to all investment and cash activity, and data can be sourced independently from prime brokers, administrators or the hedge fund managers.
Pitfalls
Of course, no investment vehicle is without its downsides – MACs won’t suit every pension scheme. For one thing, you need to have a sizeable investment before managers will even consider setting one up. As a “very rough rule of thumb” Tomlinson estimates that each managed account will likely need to be more than $25m (£14.9m) in size, ideally closer to $40m (£23.84m).
Dackombe warns that slippage – where there are differences in performance between the reference fund and MAC – can pose a problem.
“Monitoring slippage of MACs against their respective funds is very important, as the MAC should ideally perform within an agreed and understood tolerance to the main fund, and any variation could be an indication of underlying operational or investment issues,” he explains.
The costs associated with MACs may also put off potential investors, though there is an argument to suggest the increased returns and improved efficiencies gained through well-structured MACs can offset those charges.
A MAC structure can add a few basis points of costs, depending on the assets under management and the way it is run, compared with investing in the main fund, as they demand increased services to manage daily data – typically covering administrator, risk engine and risk management at the MAC sponsor’s side.
In general, Tomlinson suggests that if you are allocating a decent block of capital (£23.8m or higher) to a manager, you shouldn’t expect to pay more than for the flagship hedge fund. “In some instances, you may be able to negotiate the fees. Managed accounts can be expensive if you don’t know what you are doing, but through outsourcing it is not necessarily complex or expensive.”
Availability
If MACs are sounding appealing, the good news is there has never been a better time to get involved. Pension funds will find themselves in a strong position to negotiate terms and fees with hedge fund managers, as they are keen to rebuild their assets under management.
However, their bespoke nature means MACs are time-intensive, so some of the bigger hedge fund players may not be interested for long, particularly if the business you are offering isn’t big, or pooled with other funds.
Tomlinson concludes: “Most managers are looking for long-term investors who understand their investment strategy and business, as opposed to short-term investors who panic when things get a bit tough. Many pension funds are in a strong position to use this factor to their advantage.”
