Managed Account Monitoring
In the aftermath of the 2008 crisis, interest grew in managed accounts, in part as a way of instituting better oversight of trading and assets. That interest, in turn, led to greater attention to questions about the use of accounts. What are the benefits of different types of accounts? What level of transparency should investors target? Here we review material from the rating agency Moody's, fund administrator GlobeOp and other industry participants.
For an investor's perspective on this topic, see our conversation with Kenmar's Esther Goodman in Founders.
A report from Moody's points out that managed accounts "offer various advantages such as control and ownership of assets but also present challenges given the costs involved and monitoring requirements." Moreover, while the structure reduces certain elements of operational risk, it does not eliminate all the risk. But the benefits, costs and risks depend on the type of account an investor chooses.
It is useful to distinguish three main types of accounts. One, the investor might open a dedicated separate account with a hedge fund manager. Two, the investor can get access to selected funds via a commingled pool on a managed account platform. Three, the investor may have a separate account on a platform. Table 1 summarizes the features of these three structures.
SOURCE: Summarized from Moody's study, "Hedge funds: Investing through Managed Accounts."
Commodity trading advisors are the largest group on managed account platforms, accounting for 30% of platform assets according to Moody's. Global macro accounts for another 15%, so close to half the assets on the platforms are in these two trading strategies.
Investors have to decide whether an account offers sufficient advantages over a pooled fund, then identify the right type of account and level of customized reporting. Fund managers vary in their willingness to take on the added complexity of a separate portfolio and to provide potentially sensitive information. Platforms also offer different levels of reporting.
Long-time futures allocator Kenmar recently hired fund administrator GlobeOp to provide managed account administration and detailed risk analytics and reporting. GlobeOp chief executive Hans Hufschmid says they will provide transparency for their clients and their clients' clients. GlobeOp sends reports to investors if a manager agrees.
Table 2 shows some of the components of a report. The administrator can independently confirm pricing sources, position reconciliations, fund assets and liabilities, counterparty risk concentration, portfolio liquidity and where the assets are held in custody.
* Confirm: cash, collateral balance, over-the-counter position, pricing, investment position
* Fund Asset/Liability Confirmation: NAV, % of NAV confirmed by administrator
* Pricing Analysis: % Confirmed by administrator
* Third Party Exposures: Each third party as % of NAV
* FAS 157 Classification (from manager)
* Management and performance fee calculation.
Some managers simply will not do separate accounts, because of various complications caused by accounts compared to commingled funds. Credit fund manager Claren Road Asset Management is in this group. Suzanne Murphy, head of strategic development at Claren Road, says they want to treat all investors equally and a client with a separate account can fire the manager at moment's notice-hence the account holder would have a different level of liquidity from investors in the pooled fund, creating inequality.
John Phinney Jr., chief operating officer of Apollo Capital Markets, says managed accounts have unintended consequences. Well-intended investors create inconsistencies, for instance imposing restrictions that cause the account to drift from the fund's strategy. Hence returns in a separate account can diverge from the returns the manager makes in the fund.
Another concern managers have is about divulging trade information via separate accounts that allow investors to watch the trading. A question for the manager is whether the investor can be relied on to protect confidential trade data and making sure it does not fall into the wrong hands. Managed account platforms offer a solution; only the platform operator sees the trades.
In any case, to benefit from trade-level information an investor needs to have the capability to monitor trading and take action if there is a problem. A platform will do this for investors.
According to Moody's, institutional investors are showing increased interest in getting separate accounts on platforms, that is, "renting" a platform's infrastructure (see Table 1, third column). Then the platform operator is responsible for monitoring trades and managing the risk, as well as other functions like negotiating legal documentation with third parties.
In addition to negotiating the level of transparency and frequency of reporting, investors have to consider the question of minimum investment. A dedicated separate account typically requires a large investment. CTAs may agree to trade an account for less than a million dollars but established hedge fund managers often will not consider a separate account for less than $50 million or $100 million. There are reports of large managers that will not do a separate account unless the client commits at least $1 billion.
By contrast, commingled accounts on a platform typically have low minimum investment requirements. Another consideration is that a separate account may be easier to negotiate via a platform rather than directly from the manager, especially if the manager already has a relationship with that platform and is comfortable with the platform's monitoring.
Managed accounts and platforms that offer them are not new. For instance Lyxor, the largest platform with $10.5 billion in assets as of 2010, started in the 1990s. Account assets are still a very small share of hedge fund industry assets, though growth has been more rapid in the last two years as investors sought greater security, liquidity and control. Dow Jones Indexes and Credit Suisse recently introduced an index that tracks multiple managed account platforms, on the ground that there has been a resurgence of interest in the space due to the superior liquidity and transparency of managed accounts.
Moody's analyst Joanne Job expects that growth will continue to be strong in the short term but more subdued in the longer term as investor risk appetite returns, barring another market shock. If managers provide fund investors with the level of transparency the investors want, then managed and separate accounts will have less of an advantage and, given their higher costs, become less attractive. But many institutions now prefer to have their own account. That preference will likely continue.