Demand for Hedge Fund Separate Accounts ‘a Knee-Jerk Reaction’

Date: Friday, April 24, 2009
Author: Bei Hu, Bloomberg

Hedge fund investors’ growing demands for separate accounts may be an overreaction to increasing redemptions and fraud, participants said at an industry conference in Hong Kong this week.

Investors are demanding accounts that allow them to tailor investments, see trades and get out when they want, instead of the traditional way of pooling their money in a fund, as managers try to curb redemptions and after U.S. financier Bernard Madoff’s conviction for running a Ponzi scheme.

A record $155 billion was pulled from hedge funds last year, according to Chicago-based Hedge Fund Research Inc., while capital outflow may accelerate to $168 billion this year, a Deutsche Bank AG survey in March showed.

“It’s been a breakdown of trust,” said London-based Blaine Tomlinson, chairman of Financial Risk Management Ltd., at the GaimAsia 2009 conference. “People thought it’s related to Madoff. I think it’s got much more to do with the fact that there has been some suspension of redemptions.”

Managers have been trying to accommodate client demands as they struggle to maintain investors after industry assets tumbled 31 percent to $1.3 trillion from a peak mid-2008, according to Hedge Fund Research data.

“I think the demand for managed accounts is to some extent a knee-jerk reaction to the liquidity mismatch that the industry has had,” said Au King-lun, chief executive officer of the Hong Kong office of Financial Risk Management, a London-based fund of funds manager overseeing $10 billion.

Redemption Restrictions

As of October, 18 percent of hedge-fund assets, or about $300 billion, were subject to some sort of restriction on withdrawals, said Peter Douglas, principal of Singapore-based hedge-fund consulting firm GFIA Pte, quoting Paul Marshall, co- founder of Marshall Wace LLP, a London-based hedge fund manager overseeing about $6.6 billion.

Forty-three percent of hedge fund investors surveyed by Deutsche Bank AG in March said they were considering making a portion of their investments through managed accounts, with 9 percent of investors already doing so.

In the 1990s, fund managers required minimum investments of $100 million for a managed account, said Au. The threshold had dropped to $10 million a few years ago.

Lighthouse Investment Partners LLC, a U.S. manager of $6 billion of funds of funds, does about 35 percent of its business through managed accounts after changing its business model 3 1/2 years ago, said Barry Timmins, the firm’s Hong Kong-based analyst.

Growing Business

Harcourt Investment Consulting AG, a Zurich-headquartered manager of $4.5 billion funds of funds, has 5 percent to 10 percent of assets in such accounts, according to its Asia head Hugo van Kattendijke.

A Japanese hedge fund firm now oversees $50 million of its $200 million of assets in managed accounts, said Ed Rogers, chief executive officer of Rogers Investment Advisors Y.K. in Tokyo, without identifying the manager.

Yet managed accounts are costly both for investors and hedge fund managers. With managed accounts, clients can start demanding separate reporting, different transparency and they can change their investment guidelines, said Au.

Investors may rethink it in three or four months time, when they realize the added costs outweigh the benefit, said Tomlinson.

Costly Option

UBS AG once ran a chunk of its fund of funds business in managed accounts, said Ronnie Wu, chief investment officer of Hong Kong-based Penjing Asset Management who helped oversee $2 billion of fund of funds investments at UBS 12 years ago.

“We ended up closing them down in favor of the fund structure,” he said. “The cost of monitoring it was just not economical even for $2 billion.”

Most investors don’t have the manpower and expertise to analyze the additional information they are demanding from managers, said Rogers.

“If you can actually properly analyze all that information, you have a risk manager, you have operational teams, all that right stuff to be able to do this, you might just as well open your own hedge fund,” he added.

A managed account may also be putting investors at greater legal risk, Douglas said.

“If you invest in a commingled fund, something goes wrong, in the extreme you can sue the manager,” Douglas added. “If you own the securities through an advisory account on a separate account platform, something goes wrong, your legal defense is a bit weak.”

Separate accounts are best suited to large institutions with investment restrictions, Au said.

To contact the reporter on this story: Bei Hu in Hong Kong at bhu5@bloomberg.net