Hedge fund managed accounts, a niche solution
This fund distribution method, which is safer for investors, has returned to its pre-crisis levels while revealing its limitations.
Faced with the lack of transparency, risks of fraud and liquidity constraints of hedge funds revealed by the crisis, segregated accounts platforms are seen as a solution by an increasing number of investors. Managed accounts enable investors to invest in alternative investment funds, without any operational risk exposure.
According to the data published by HFMWeek, the ten biggest players had 52.8 billion dollars under management at the end of 2011, i.e. 27.7 % more than in the previous year. Lyxor AM, Deutsche Bank and Man Group are still the three biggest platforms. According to some observers, the sector as a whole could even represent as much as 80 billion dollars, if all platforms and dedicated mandates are taken into account. But this strong growth hides another reality. Managed accounts still represent only 2.5 % of the hedge fund universe, which had total assets of 2,000 billion dollars at the end of 2011, according to HFR estimates.
Because they were the only hedge funds to offer liquidity windows, managed accounts suffered during the crisis. But, in terms of assets under management, they have returned to the pre-2008 levels. "The recovery in investments since 2008 can be broken down into two phases, notes Martin Fothergill, Managing Director at Deutsche Bank. Initially, funds of funds and private banks, which wanted greater liquidity and better risk controls, turned to us as a reaction to the Madoff affair and the liquidity constraints imposed by numerous funds. But above all the composition of the market changed sharply, from 2010, with the arrival of institutional investors." This view is shared by another major operator in the sector. "In the current context, they want to increase their allocation to hedge funds while avoiding risks of fraud, excessive leverage or other types of liquidity problems inherent in the industry, adds Nathanaël Benzaken, Head of Development at Lyxor AM. They are increasingly turning to managed accounts. The aim is to reduce hedge fund risk solely to its market risk, in other words the performance driver." In comparison with a direct investment, these platforms offer investors greater operational security, better risk management, liquidity and transparency.
Investors delegate trading responsibility to the fund manager, in other words the latter is only empowered to place orders on the securities that it wants to buy or sell. As for the assets, they remain the property of the managed account. "The most important aspect is the selection of funds, notes Laurent Guillet, CEO of Amundi AI. We are not a distribution platform whose objective is to reference as many asset managers as possible. Our approach is management-centric. Our aim is solely to pick the best fund managers. We attach particular importance to this since Amundi AI’s funds systematically use the platform." Innocap, the platform which was launched in 1996 and is now equally owned by National Bank of Canada and BNP Paribas, employs a forty-strong team. "The choice of hedge funds may come from an institutional client but, most of the time, it is based on the screening of the universe of hedge funds by our teams in cooperation with those of Theam", explains Ramez Chalhoub, Head of Business Development at Innocap. In both cases, the funds selected are subject to a due diligence process. The analysts organise meetings with the managers, make on site visits, interview the various parties involved (prime broker, custodian bank, administrator, etc.) in order to satisfy themselves as to the quality and long-term viability of the hedge fund. "At the end of the day, it is a selection committee that decides whether the fund can be integrated into the platform", emphasises Eric Debonnet, Head of Hedge Fund Solution at Theam. The selection process is however just the beginning: "We monitor investments in detail and analyse the portfolio on a daily basis to satisfy ourselves that it conforms to the management mandate", adds Ramez Chalhoub.
The decoupling between the original fund and the platform provides investors with greater security. "We are totally disconnected from the operational organisation and services of the fund manager, and we determine our own architecture, stresses Laurent Guillet. We are therefore responsible for the valuation processes, as well as monitoring management rules and controlling liquidity. This guarantees a secure framework for the fund." Funds are therefore fully adapted to the investor’s specific approach and constraints. "Our teams determine acceptable risk limits by analysing the risks that the fund takes, notes Pierre-Yves Moix, Chief Risk Officer at Man’s multi-manager business. Once a fund has been selected on the platform, the contract concluded between Man and the fund manager specifies the VaR (‘Value-at-Risk) based risk limits, the instruments which can be used, product liquidity, etc. If these limits are exceeded, the contact can be terminated in 24 hours."
However, managed accounts raise certain questions. First of all, these platforms have their limits in terms of eligible products. "Not all strategies can be replicated, confirms Bertand Gibeau from Reinhold & Partners. There’s no magic wand. It is sometimes difficult to reproduce a certain type of fund, while remaining liquid. Finally there may be significant tracking errors (read the interview). These barriers may hamper the development of these managed accounts. But an even bigger obstacle is the cost of the platform and this is one of the major stumbling blocks for investors. "Most of the solutions on the market are more expensive for the end client, emphasises one fund manager. It is a particularly acute problem in a context of pressure on costs." But the liquidity offered by these platforms has a cost. "The security that they offer involves significant work and this has a cost", stresses one market player. "The costs inherent in the platform range from 0.5 % to 0.65 %, but at Innocap we try to negotiate fees with fund managers as soon as they are referenced on the platform, then we pass these on to our clients", acknowledges Ramez Chalhoub.
To gain a market foothold, new entrants are proposing lower fees and more open platforms. Syz & Co, which has recently launched a managed accounts platform with UBS, has made this choice. The liquidity proposed by the platform’s fund is identical to that of the offshore fund and enables the latter to keep its counterparties in order to reduce tracking errors as far as possible. "The objective is to make performance quality a priority", notes José Galeano, Head of Alternative Investment at Syz & Co. The Swiss bank also places the emphasis on the cost of accessing the platform, which is among the lowest on the market (around 0.3 %). "Our pricing policy is in line with the new situation on the institutional investor market." Institutional investors are putting more and more pressure on fund managers to reduce their fees. "The operational choice of investing in a hedge fund is not a black-and-white choice between, on the one hand, a direct investment in a fund and, on the other hand, managed accounts, notes Gabriel Bousbib, Chief Operating Officer at Gottex Funds which operates the Luma platform. Between these two extremes, there is a myriad of choices as regards governance, operational controls, valuation, etc. This reflects the way in which the market is developing. Institutional investors want more choice and a more flexible approach than that which is currently offered to them by banks operating segregated accounts platforms."
"At the current time, there is a mixture of managed accounts and simple platforms which merely host funds at a fairly low cost, but without the same level of risk controls", warns Bertrand Gibeau. Investors therefore need to be very vigilant regarding risk controls, IT capacity, etc. This recommendation is particularly timely since the hedge fund industry has started to recover at the beginning of 2012,after a very disappointing 2011 in terms or performance. The flow of redemption requests from investors even seems to have come to a halt. Managed accounts platforms already seem to be benefiting from this trend. Deutsche Bank’s assets under management reportedly exceeded those of Lyxor in February, with an estimated total of 12.2 billion dollars. 2012 promises to be a good year for the sector.