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Managing expectations

Written by Christine Senior
October 2011

Christine Senior explains the reasons for investing in managed accounts

The financial meltdown of 2008 and subsequent Madoff fraud profoundly affected investors' attitudes to investing in hedge funds. Investors lost money as well as facing gates from hedge fund managers when they sought access to their funds.

No wonder interest in managed accounts and managed account platforms has taken off since the dark days of 2008. Individual managed accounts with a broker enable investors to keep assets in a segregated fund and appoint hedge fund managers to run the money
in line with their strategy. But with this comes a significant operational burden and associated costs.

Alongside these, managed account platforms offer a means for investors to invest in a range of hedge funds appointed by the platform provider. The responsibility for operating and monitoring these relationships lies with the platform provider. Assets on managed account platforms in Europe are estimated by Sciens Capital to be around €30 billion and growing rapidly, and new platforms continue to be launched. Between an individual managed account with a broker and a commingled account on a platform are a range of possibilities.

One of the main selling points of managed accounts is the choice and flexibility they offer. Managed account platform provider Gottex Solutions Services CEO Gabriel Bousbib sees managed accounts as a "continuum of solutions". "It's not a binary choice of either a separate managed account for the investor alone or a commingled fund with no transparency.

"We see investors, depending on their circumstances, deciding where and how they want to invest. It could be through a managed account where they are the only investor, through a managed account where they are commingled with other investors, or it could be through a commingled vehicle where the fund administrator provides to them or to a third party all the positions in the fund. Then of course they can invest in a regular commingled vehicle where they have limited transparency."

Not all platforms are the same: from the biggest to the smallest, the choice of funds and the range of services offered varies considerably. Lyxor Asset Management, with 110 underlying managers, the largest managed account platform, is constantly evolving services offered and adding to its array of hedge fund managers.

A new development is that some of the larger pension funds are starting to set up their own managed account investment programme rather than allocating to an established platform. Independent fund administrator GlobeOp managing director Ron Tannenbaum sees a trend emerging.

"These large, sophisticated funds know exactly what they want. They have their own fund due diligence, analytics and risk control groups in place, and know what reports and data they need from us. After having worked with, learned from (and paid fees to) funds of funds and then the managed account platforms, pension funds are moving toward having their own bespoke structures on the larger managed account platforms. Other experienced pension funds are creating their investment platforms in-house and outsourcing their administration requirements."

The overriding reason for the rising popularity of managed accounts is the protection of assets they offer. Because the assets are held on the platform, not directly by the hedge fund, they can't suddenly disappear if the hedge fund blows up or the manager is hauled off to jail in handcuffs.

Lyxor head of managed account development Nathanael Benzaken says: "The first advantage which is most important after Madoff and all the other scandals is that managed accounts guarantee full segregation of assets, ultimate protection against fraud. When you put your money in, you can sleep at night without taking the risk of waking up, opening a newspaper and seeing Madoff has been arrested by the FBI and stolen $50 billion of assets."

Managed account platforms also offer improved liquidity and transparency.

"The managed account platform will have weekly liquidity or maybe fortnightly or monthly liquidity whereas if you were to invest in the same commingled fund managed by the hedge fund manager you might be on quarterly liquidity," says Cardano hedge fund specialist Chris Parkinson.

"Also, depending on the platform you use you can have access to transparency on what the hedge fund is holding. If you want to know exactly what your money is invested in line by line in the portfolio the managed account platform may be able to provide it. If they can't they will be able to provide aggregated exposures."

Another of the benefits of investing in a managed account platform is the independent valuations provided.

"In most commingled hedge funds the investment manager has the final say on the valuation of the assets, which could provide a conflict of interest for illiquid assets," says Bousbib. "The fund manager gets paid a performance fee which could be on a valuation which is not realistic. In a separate managed account on a platform, the platform operator will always be responsible for the valuation of the assets. It's a more independent process."

Operational risks are also reduced because the platform sits between the investor and the underlying hedge funds. The platform has its own service providers, effectively offering a further level of monitoring.
"In a regular fund you have three players - the prime broker, the manager and the administrator," says Bousbib. "In a platform of managed accounts you have at the centre of the triangle the platform operator. You have an additional set of eyes."

But there are downsides as well as benefits to managed accounts and platforms. Investing only in managed accounts has historically limited investor choices - not all hedge funds accept them. Both investors and hedge funds need extra resources to deal with them, and the funds may have to reveal more about their strategies then they would choose to. If they don't need to attract investors through offering managed accounts, they don't do it. This is referred to as a "negative selection bias", and applies both to direct managed accounts and platforms, according to Parkinson.

"I don't know what proportion of hedge funds in the universe offer or accept managed accounts but I believe it would be the minority," he says. "If you go via a platform in return for better access for smaller investors there is a much bigger negative selection bias. For direct managed accounts it's really a function of the type of investor you are and the size of your allocation.

If a very high quality long term investor who can make a significant allocation goes to a big successful hedge fund, the fund may be more willing to entertain the idea of a managed account."

But others believe that the events of 2008 forced hedge funds to look more favourably on managed account platforms as a source of investment capital. This is the view of managed accounts provider Sciens Capital senior marketing director for institutional business development Michael Hart.

"Before 2008 a much larger percentage of hedge fund managers would have said they didn't need managed account platforms. Now it's a complete turnaround. Hedge fund managers want 'sticky' money - long term institutional money. Since 2008 they have become more aware of investor concerns. Because managed account platforms offer improved liquidity, transparency and risk management hedge fund managers realise to get sticky money they need to be on a managed account platform."

Costs are also often mentioned as a disadvantage to using managed accounts. In addition to the costs of the underlying hedge funds, already significant, each platform levies its own charges. Benzaken reckons these are low for the benefits gained.

"Invest through a managed account and you pay a few basis points," he says. "I can guarantee your assets will never be subject to fraud or blow-up. Effectively this could be looked at as an insurance premium. Would you put your reputation, your work, your assets at risk for a few basis points?"

Written by Christine Senior



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