Hedge Funds Struggling With SMAs

Hedge fund firms are struggling with trade allocation issues when it comes to managing separately managed accounts, or SMAs, alongside the fund. A growing number of investors in recent months have requested SMAs to benefit from, among other things, more transparency, tailored strategies and the ability to request more or less exposure to certain types of assets. Michael Tannenbaum, partner at Tannenbaum Helpern Syracuse & Hirschtritt in New York, said SMAs have grown more popular because clients want more control and safety in an uncertain environment.

Managers are obligated to execute trades for SMAs at the same time as trades for the fund, said Michael Mavrides, partner at Bingham McCutchen in New York, but if the fund and the SMAs are using different brokers it can be difficult to ensure best execution. “You can’t really group the trades if they’re all using different brokers. And as soon as the manager buys for one [client] the stock goes up. So funds are [questioning] how to rate them.”

Firms must have specific policies and procedures in place related to trade allocations and best execution that are designed to treat all lines of business in a fair and equitable manner, Mavrides said. But, he added, “Managers are not doing that. Their policies are not that specific.”

A CCO in Boston said his firm recently started documenting the rationale for all its trade allocations, including why it placed the fund or an SMA first. Another problem, chief compliance officers said, is that investors in SMAs can take advantage of the additional information they receive to engage in front-running, among other things. “You have to be careful how you deal with SMAs,” said a CCO at a New York-based hedge fund firm. “It is easy for investors to abuse their positions.”

A CCO based in Connecticut said he is in the process of creating a software system that will compare data between the hedge funds and SMAs his firm manages in an effort to ensure one is not front-running the other. The system is set to debut by the end of the second quarter.

Managed accounts are drawing the Securities and Exchange Commission’s attention. Andrew Donohue, director of the agency’s Division of Investment Management, in a speech March 21 in Washington, D.C., said firms running managed accounts should be “attuned” to how they are meeting their obligations. “If client trades will be placed with the managed account’s sponsor, the adviser should be comfortable that this arrangement achieves best execution and that the client is informed of this arrangement and why it achieves best execution.” An SEC spokesman declined to comment further.