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More Firms Expected to Add Hedge Funds to Separately Managed Accounts

Date: Sunday, November 7, 2004

NEW YORK (AP) - Hedge funds may be coming to a managed-account program near you. Separately managed accounts, or SMAs, are individual accounts that allow affluent investors to own stocks and bonds hand-picked by a money-manager. However, SMAs are currently only available in the same flavors commonly found in the mutual fund world _ large-cap value and small-cap growth, to name two. Now, however, more firms are expected to add a slightly more exotic side dish with SMAs: hedge funds, namely registered funds of hedge funds. "It's going to happen. I would be surprised if a year from now someone hasn't cracked the code," said Robert Alderman, managing director at Merrill Lynch Alternative Investments, at a recent SMA conference held by the Money Management Institute. That so-called code has to do with technical, legal and other challenges that come with incorporating such complex products into SMA platforms, as well as unified managed account platforms, which are also individual accounts but ones that house a variety of investment products, from SMAs and mutual funds to exchange-traded funds. Indeed, only "accredited investors," or those with a net worth of at least $1 million, can even invest in registered hedge fund products. However, at least one firm has managed to make it work. Lockwood, part of Bank of New York Co.'s Pershing unit, the seventh-largest SMA provider, offers some registered funds of hedge funds on their platform, along with many other investment products. Registered funds of hedge funds "are not going to shoot the lights out," said Len Reinhart, a managed-account industry pioneer and Lockwood's president. "We are using them because of their low correlation with the equity markets. What really forced the issue was you got into a bad equity market and clients start to ask, 'How do I diversify further? The market is making me nervous, what can I do to protect myself?'" One of the hurdles is dealing with the very nature of hedge fund products, which have limited transparency, are less liquid and don't report their performance daily. "It's an uneasy fit, but I think (SMA sponsor firms) will find a way to include it," said Rick Cortez, president of the private client group at Torrey Funds, a New York firm that invests in hedge funds, and part of the Money Management Institute's alternative investments committee. Fees will be additional, and not part of the all-inclusive SMA wrap fee. "Clients can decide if it's a good fee or a bad fee, but I don't think it can be wrapped," Cortez added. Another issue, Reinhart noted, is linking the reporting on behalf of the hedge fund products into advisers' workstations so they can view it with their clients, Reinhart says. "Hedge funds provide a diversification opportunity that is excellent for SMA programs," added Chip Roame, managing principal of Tiburon Strategic Advisors, a research-based consulting firm in Tiburon, Calif. However, Roame was quick to stress that many hedge fund products that take inordinate amounts of risk don't belong in the average SMA investor's portfolio. He also believes that sponsor firms have to come up with an adequate way to provide some sort of transparency of the underlying holdings and valuations on a periodic basis. "You have to at least be reporting to clients quarterly," he said. "If (they don't), how do you call it a managed account?" Still, he believes many of the large sponsor firms will overcome those obstacles within the next twelve months or so, especially if the markets remain tepid. If the market keeps trending sideways, then hedge funds with absolute-return strategies, or those returning the same thing in any market, will be more in demand, Roame said. "That will make brokers and firms clamor to offer (these products)," he said. Several firms are in the midst of developing unified managed account, or UMA, programs which would take separate accounts and its product offerings a step further. Smith Barney, the brokerage arm at Citigroup Inc., has been a UMA trailblazer, rolling out its version, called Integrated Investment Services, about a year ago. It doesn't currently offer alternative products like hedge funds, but spokeswoman Kimberly Atwater said it wouldn't rule it out in the future. UBS AG doesn't offer hedge funds as part of its SMA platform. However, spokeswoman Susan Austin said the firm is intent on developing a UMA-type program that will also incorporate certain registered fund-of-funds. Morgan Stanley said some of its larger separately managed account clients have access to hedge funds. However, its version of the UMA, called Personal Portfolio, continues to expand its product offerings, and they'll continue to explore adding alternative investments, including hedge funds, as the platform evolves. "The best we can do right now is a manual process," Merrill's Alderman said. "If it's a good thing for the client, we ought to as an industry (figure out) how to provide it for suitable investors."