The performance gap of managed accounts is structural
The differences versus “replicated” hedge funds can be attributed to investment divergences.
The liquidity, transparency and rigorous operational risk controls promised by managed accounts come at a cost, in terms of both management fees and results.
According to a recent study* comparing the performances of the Lyxor platform with those of the underlying funds (the initial findings of which were presented at the last annual “Hedge Fund Research Conference” in January in Paris), the greater liquidity offered by managed accounts reduces performance by 2.82% a year. The analysts of the alternative multi-management firm Olympia Capital had carried out the same exercise in 2009, with a performance gap risk of up to around 6% in some cases. “We do not agree with the conclusions of Charles Cao and his colleagues, asserts Stefan Keller, Head of Research and External relations at the Lyxor platform. In particular it is necessary to balance the findings to take account of the statistical bias and the methodological shortcomings of the survey.”
In fact the American researchers have worked on the basis of performance assumptions since these data are not published. “While the net asset values of hedge funds can be consulted in various specialised databases, that is not the case of the performances of the funds lodged in managed accounts”, confirms Fabrice Cuchet, Head of Alternative Management at Dexia AM. Lyxor has indicated that it is willing to communicate more precise data to Charles Cao to enable him to refine his results. “The problem of these studies is that they cannot take into account the details of agreements concluded between the platform and the investment manager”, adds Eric Debonnet, Head of Hedge Fund Solutions at Theam (BNPP IP group).
For Frédéric Lebel, Co-CEO and CIO of OFI MGA, in which the Man group has recently acquired a 20% stake, there are three potential sources of performance gaps: miscellaneous expenses, the exclusion of sub-strategies and the means of implementing the strategy. Expenses range from 50 to 80 basis points, depending on the platform and the fund. However, this needs to be put into perspective, since as Alain Albizzati, Head of Alternative Investments at Lazard Frères Gestion points out: “This layer of additional expenses reduces the performance of the underlying funds but its impact remains limited. For example, in a strategy which targets a return of 10%, 75 basis points of expenses will represent only 7.5% of the performance.” In addition, managed accounts negotiate the expenses due to the funds for their clients. “One should not think in terms of infrastructure expenses charged by the platform of managed accounts, stresses Olivier Dubost, Managing Director with responsibility for Man GLG’s distribution in France and a member of the Supervisory Board of OFI MGA. It is necessary to evaluate systematically the TER (total expense ratio) of each managed account since we negotiate, in favour of our clients, the management fees and administrative expenses.”
The real source of the performance gap lies in the constraints imposed by managed accounts. “At least 80% of the gap is linked to the risk calibration, management constraints and the investment universe”, asserts one portfolio manager. The better liquidity offered by managed accounts (monthly, weekly and even daily) will result in different investment rules. To ensure a match between the promised liquidity and the underlying investments, it will not be possible to include certain investments which are not readily tradable in the funds lodged on the platform, thereby depriving them of part of the strategy and, consequently, part of the performance. The same is true for risk limits: “One of our CTA funds is lodged on a platform with a lower risk level, says Fabrice Cuchet. It is calibrated to have a volatility which is 20% lower than that of the underlying fund. The same strategy is implemented in both funds but the positions are different." Similarly, the leverage allowed by risk management policy of the managed account may be different from that of the fund. Finally, in certain cases, such as UCIT funds where short sales are not allowed, the managed account must replicate the same positions via other instruments such as swaps, thereby generating additional costs. The most exotic and least liquid strategies, involving for example credit and distressed securities, are more vulnerable to this type of deviation. The most liquid funds such as CTA and long/short equity strategies are the easiest to replicate completely.
To conclude, there is a difference. More than half of the 120 funds of the Lyxor platform had a deviation of less than 100 basis points in 2012. The biggest deviation was 1,000 basis points, resulting from a structural tracking-error in respect of a “special situations” strategy not fully replicated on the Lyxor managed accounts platform. “A third of the deviations was nevertheless positive”, nuances Stefan Keller.
*“Liquidity costs, return smoothing and investor flows: evidence from a separate account platform”, Charles Cao and Grant Farnsworth of Pennsylvania State University, and Bing Liang of the University of Massachusetts.