Managed accounts not seen as the panacea investors desperately seek

Will managed accounts be the structure of choice in future for funds of funds and for investors?

There has been a lot of talk about managed accounts and variations of them, particularly since the market meltdown forced funds to impose gates, lock-ups and suspend redemptions rattling investors. On top of that the Madoff scandal further shocked investors. The stampede to managed accounts has not quite materialised yet. The verdict on their feasibility is still out. While there are many eager and willing to espouse their attractions, there is an equal number counting the reasons managed accounts might not be the perfect solution for the majority of investors or hedge funds.

That the industry will change is commonly agreed. How is not quite so clear. While there is likely to be some large investors and funds willing and able to move into managed accounts, other less-costly solutions may yet be found.

Simon Clowes, VCM Fund Management
We have seen an increase in requests for the managed account (MA) structure and view this as something of a reaction to the Madoff scandal, which raised important questions about transparency, liquidity, operational integrity and the quality of external service providers. The perception is that investing in an MA structure affords the investor a greater level of control over their assets. However, additional infrastructure issues and a lack of hedge funds willing to offer MAs, dramatically reduces the potential investment universe. We cater for clients interested in investing via MAs. We do not believe the same levels of transparency and liquidity cannot also be reached through a more traditional hedge fund structure. Most of the assets lost in the Madoff scandal were in fact in MA vehicles. The platform model enables full transparency on funds, which in turn can be provided to investors. We have always offered monthly liquidity with no gates. This provides the comfort of a complete segregation between infrastructure and fund management responsibilities ensuring an independent risk oversight on all our funds. The current popularity of MAs will temper and re-balance when hedge funds shift towards offering investors the liquidity and security they demand.

William Drake, Lord North Street
In bubbles investors make the mistake of thinking asset values will continue to rise because "something is different this time" and in bear markets they start to think that the rules of investing have changed and things will go on getting worse for ever. After the extreme trauma of 2008 this is what is happening in some parts of the hedge fund market at the moment. Investors have had to re-learn some old rules about investing. First, you need to know who your co-investors are and try to predict how they will react to bad news. Second, it is no good relying on a structure to provide liquidity when the underlying securities become illiquid and your co-investors want out. When investors are all running for the exits at the same time, the integrity of a fund structure can break down in any asset class. Some hedge fund investors will move to using managed accounts while others will achieve good results from investing in funds as conditions normalise. One important test will be to assess whether the hedge fund manager has correctly adjusted his redemption terms to the liquidity of the underlying strategies deployed in the fund. Managers who have gated can expect to be shunned.

Sean Curry, TriAlpha Investment Advisors
Managed accounts (MAs) appear to address the need clients, especially institutional clients, have for enhanced transparency. This appeal has broadened to a wider group of investors who also see the added advantage of potentially more favourable liquidity characteristics. The debate is quite nuanced. The hedge fund industry is extremely non-homogenous and the MA solution may only truly be optimal for a small subset of managers. One of the obstacles is the additional operational complexity that MAs present for clients and, more importantly, managers. There is a requirement for a level of operational depth that might exceed the available infrastructure, especially smaller managers and start-ups. This obstacle might not stop a manager offering this facility to clients, especially if they are hungry for asset growth. Then a client must be willing and able to assess if there is an above-average frequency of trade breaks and identify where there is proper allocation of trades and whether all mandate restrictions are fully met. Hence the burden on the client is raised, as they will be expected to utilise and monitor a considerably higher volume of data and become involved in the complexity of account set-up and counterparty agreements. There is also the question of the potential costs.

Donald Conrad, Conrad Capital Management
A combination of factors will make managed accounts (MAs) the norm for sophisticated investors. Any monies that will be reallocated back to money managers in the third and fourth quarters of 2009 will come with many strings attached and much of it will be invested in the form of MAs. All money managers are subject to independent operational reviews (physical inspections and confirmation of all service providers) for adherence to best practices and to spot any red flags of suspicious activity. Assets are not commingled with other investors and clients can place restrictions on individual holdings. Investment strategies can be customised and risk levels are personally crafted. Investors have greater control and security over their assets. Would you prefer multiple managers watching 50 or fewer securities or one money manager watching 150 stocks? In today's environment it is better to have many people guarding the hen house. MA transparency gives investors portfolio tracking 24/7. Outdated quarterly and semi-annual disclosures are no longer acceptable. MAs allow clients to view positions almost on a daily basis.

Aleks Kins, AlphaMetrix
There is new interest in managed accounts (MAs) but once investors and fund managers start to consider them, they quickly realise that for all their strengths, they bring new operational and portfolio risks. For the shell-shocked investor, MAs are appealing for a variety of reasons: money is custodied at a prime broker instead of the manager, and they offer full account transparency and greater liquidity. However, MAs have serious downsides, such as unlimited theoretical risk from excessive leverage or toxic instruments that might make it into their portfolios. Investors have had to make huge investments in technology, operations and risk management to stay on top of market exposure and trading activity. For the fund manager MAs are a great way to attract new capital but are an operational and administrative nightmare, causing an operational burden. Traders have to strike a balance in offering MAs. Ultimately, their weaknesses have kept them from taking off. What our experience shows is the growth in MAs will be driven by new solutions to their challenges rather than by marketing their benefits.

Alexander Ahari, Eddington Capital Management
Managed accounts (MAs) house a significant percentage of our underlying investments and have provided us with valuable liquidity and transparency during these extremely challenging times, as well as being actively used for balancing portfolio risks. MAs offer investors a number of advantages over pooled funds but require more in-house resources to set up and maintain. In the wake of recent high-profile frauds and redemption suspensions, investors are gravitating towards them for the superior security, liquidity, transparency, and pricing they offer. Falling assets have increased the pool of managers willing to run MAs, often for smaller investors who would not previously have met the minimum funding requirements. But MAs don't suit all strategies and the best managers may refuse to use them, preferring the simplicity of a pooled fund for all their investors. So while MAs offer a unique solution to changing investor demands, and will certainly play a significant role in shaping the future of the hedge fund industry, the traditional fund structure isn't dead yet.

Tony Gannon, Abbey Capital
Where it is feasible and practical, managed accounts (MA) might be the only acceptable structure for funds of funds (FoFs) in the future. FoF clients may question the value of their manager if the manager does not have full visibility and is not in a position to monitor their traders' positions on a daily basis. The MA structure has not occurred often in the past mainly due to costs of building a full MA platform and the associated risk monitoring. Because of the costs we expect to see consolidation within the FoF business, with a small number of large players using an MA structure. There will be higher barriers to entry into the industry. It will no longer be acceptable for underlying hedge fund managers that trade in liquid instruments to refuse an MA to large FoFs. Institutional and pension fund investors who fear the unlimited liability associated with direct investment into MAs will look to invest through FoFs that offer full transparency and risk management. These clients will also expect a gate-free investment. The only area where MAs may be difficult to implement is in venture capital or some of the illiquid strategies.

Martin Baxter, Collins Stewart Fund Management
Transparency is a major issue for investors, which can be solved by the setting up a managed account (MA). The investor should be given the portfolio that gives them a great deal of comfort. An investor can track their investment and have the comfort of knowing that it is in tandem but separate from the open-ended vehicle so the portfolio will not be affected by cash flows. This seems like the perfect tool then. Unfortunately the use of MAs is outside the realm of most. An investor wanting to use a vehicle like this will require upwards of $50 million and some require a minimum of $100 million. They will also have tighter liquidity restrictions due to the cost of setting up the vehicle. Platforms also represent another vehicle for an investor. The investment minimums are lower and the liquidity terms are better. However, the investor doesn't have the same transparency as an MA but the platform provider does. The investor also has the added risk that the platform provider is performing their due diligence and it is financially secure. So MAs do represent an interesting option for investors as long as they can hurdle the minimum requirements.

Howard Altman, Rothstein Kass
Post-Madoff there has been much discussion regarding managed accounts (MAs). Their advantages include transparency, liquidity and strategies that can be tailored. In addition, since there are no accredited investor requirements, it would seem this would allow companies to draw assets from a considerably larger pool of investors. However, we have found that most fund managers are not planning to enhance or introduce MA services. Increased overhead costs are one of the downsides. Since MAs do not typically require an 'entity' audit, there is uncertainty as to who bears responsibility for determining the fair value of underlying portfolio assets. MAs may also eliminate many of the investment tools required to deliver market-independent returns. While investors might believe the ability to dismiss managers in favour of the hot strategy is essential, they might also find it difficult to resist the urge to chase returns. The benefits of greater investor control may vanish when decisions are made without advice of the professionals who were retained because of their experience and insight in the first place.