The choice will depend on the investor’s needs
The performances of hedge funds and those of managed accounts may differ. Why?
Two important factors need to be taken into account. First, the additional cost paid by the investor. Secondly, the performance difference between the replicated fund and the managed account. This difference can be attributed to several things, in particular investment or leverage constraints imposed by the platform. A survey carried out by us at the end of 2008 revealed that the median tracking error was 3 %, with as a result excess volatility of 20 % and a 15 % lower return for managed accounts. We have not updated our research but the figures are unlikely to be very different as long as segregated accounts are subject to the same constraints.
Are some strategies more sensitive to tracking errors?
Yes. Everything will depend on their complexity and level of liquidity. Directional strategies using simple assets such as futures for their investments have a lower performance differential than relative value strategies. For example, global macro, CTA (commodity trading advisors) and long-short equity strategies in large caps had median tracking errors of between 2.3 % and 3 % versus 6.1 % for relative value strategies (credit arbitrage, convertible bonds, mortgages, etc.). The latter are the most affected by the investment universe and leverage restrictions imposed by managed accounts.
This extra cost may appear high after a difficult year in 2012 for many hedge funds…
It is the price to be paid for the security, liquidity and transparency offered by these platforms. Today, tracking errors are no longer a surprise for investors. Even providers of managed accounts warn their clients about these differences. In the end, the choice will depend on the investor’s needs. In the current period, some investors may want greater flexibility to be able to close out positions rapidly. In addition, the operational risk management which is entrusted to the managed accounts provider must be remunerated. Finally, from a regulatory point of view, in particular for insurance companies within the framework of Solvency II, managed accounts may provide greater transparency via detailed, customised reports, which could in the end enable them to reduce their capital investment obligations.