Institutional investors want to invest in hedge funds. But not every investor has the staffing, time, and other resources to identify promising funds, perform initial and ongoing due diligence, and gain access to hedge funds that can meet their needs. That’s why some investors are moving toward using a managed account platform. The right platform can offer a desirable mix of lower fees and expenses, better control and governance, transparency, customization, and more.
Move toward managed accounts
Institutional investors are increasingly turning to managed accounts for their hedge fund investments. Managed accounts are segregated accounts hosted on a platform, but, importantly, owned and controlled by the investor. Investment decision-making is delegated to an appointed sub-advisor—in other words, the hedge fund manager. The managed account platform is responsible for selecting the sub-advisor and assessing the suitability of the sub-advisor’s investment strategy and approach. The platform also provides middle and back office functions.
The move toward managed accounts accelerated following the global financial crisis of 2008–2009. Until then, hedge fund managers easily attracted assets to commingled accounts with their standard high fees and terms. As demand for their funds softened post-crisis, partly due to increased investor skepticism of actively managed funds (including long-only and hedge funds), hedge fund managers became more open to negotiating with investors bringing them sizable assets. This opened the way for the growth of managed accounts. Reflecting this trend, 62% of investors planned on investing in a fund with customized fees and liquidity terms, according to Ernst & Young’s 2017 Global Hedge Fund and Investor Survey.1
Investors are using managed account platforms offering access to hedge fund strategies because the managers of those platforms take over the time-consuming account set-up, monitoring, and other tasks that investors lack the resources to perform themselves. They also benefit from the greater negotiating power of platforms that aggregate assets.
What to look for in a managed account platform
Because of the resources required to negotiate managed accounts, investors are turning to managed account platforms. A managed account platform takes advantage of the platform manager’s scale and expertise to screen and select hedge fund managers, negotiate favorable terms, and run the accounts’ middle and back office functions. Each hedge fund manager retains only trading authority.
Managed account platforms are not all the same. Many providers aim to offer access to a broad list of hedge funds. In contrast, we believe the best platforms strive to optimize the benefits of managed accounts as the platform manager invests alongside clients in a carefully screened collection of investment strategies. Investing alongside clients gives the manager a powerful incentive to seek the best funds on the best terms. The right platform manager will also have a differentiated due diligence process to help identify hedge fund strategies that appear attractive in terms of risk-adjusted return potential. Ideally, the platform manager will use that skill to create a short list of accounts, instead of a long list that leaves the investor uncertain of which accounts the manager considers its best ideas.
Investors should seek a managed account platform with the scale and resources to deliver outstanding benefits in the following areas.
- Fee reduction. Hedge funds are amenable to negotiating fees with end clients, provided the investment amount is big enough. Managed account platforms allow for economies of scale by aggregating individual investors into a single entity, thereby increasing the platform’s negotiating leverage with the hedge fund. With the right platform, hedge fund managers may significantly cut fees, including incentive fees. Platforms can also customize fee terms to increase alignment of interest with the hedge fund manager. For example, they could add a hurdle fee or delay the crystallization of incentive fees, so a hedge fund manager must produce positive returns over a period of a year or more to realize their incentive fees.
- Expense control and transparency. Hedge funds typically lack the straightforward expense ratios of mutual funds. A managed account can set clear terms at outset so that hedge funds don’t pass through—or at least cap—certain expenses charged to investors. For example, the terms may specify that the hedge fund cannot pass through expenses for marketing trips, and that research expenses should be paid out of the management fee.
- Control, governance, and liquidity. The managed account platform will appoint the account’s board of directors. It can also customize investment guidelines to achieve the optimal value proposition. For example, it could control leverage or net exposure. It could also specify that the account may not invest in tobacco stocks or other investments that aren’t compatible with an ESG mandate. Its control also means that it—not the hedge fund manager—owns the account’s assets. This control also allows anonymity to clients that are wary of potential headline risk.
- Portfolio transparency. With commingled accounts, hedge fund managers typically release summary-level portfolio detail on a monthly basis. With managed accounts, daily position-level reporting allows the platform manager’s investment and risk teams to monitor that the accounts are sticking to their strategies and not evolving in ways that undercut their intended role in a broader portfolio.
- Better alignment of interests. We believe a managed account works best when it is owned by a party other than the hedge fund manager—the platform manager—whose interests are aligned with those of investors. This works best when the platform manager invests alongside the other investors.
- Operational oversight. The platform manager appoints all of the back and middle office service providers. It’s important to find a platform with a strong line-up of specialized service providers and oversight of trading.
|Advantages of the Right Managed Account Platform Over Commingled Funds|
|Benefits||Managed Account Platform||Commingled Fund|
|Expense control and transparency||YES||NO|
|Control, governance, and liquidity||YES||NO|
|Better alignment of interests||YES||NO|
Picking the right managed account platform increases the potential for hedge fund investments to help portfolios achieve their goals. Find the right platform, and your portfolio, too, can benefit.
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