Hedge fund managers act to regain trust

After bitter experiences with hedge funds last year, investors want a better deal. Angry that they were prevented from redeeming their investments and newly cautious following the revelation of the Madoff fraud, many investors are asking hedge fund managers to provide them with managed accounts.

A managed account can be anything from a hedge fund manager running money specifically for a single investor to an absolute return product provided by a third party platform that offers administration, custody and a degree of fiduciary oversight.

Some proponents of these structures see them as a panacea to all that was wrong with the hedge fund world. In theory they offer transparency, immediate access to assets and tighter control of the assets. In practice, this can be the outcome of using managed accounts but it is not a foregone conclusion that they will improve the situation.

“We have seen a definite increase in clients asking for us to draft [managed account] documentation for them,” says Martin Cornish, partner at law firm Katten Muchin Rosenman Cornish, whose clients are mostly hedge funds considering client demands for managed accounts.

Although one of the main advantages of managed accounts is supposed to be transparency, this is not necessarily as helpful as investors imagine.

“What we hear is that some investors can’t actually interpret the information that wisely,” says Mr Cornish. “And if you [a pension fund] have the information, you open yourself up to criticism that you knew what was in the portfolio but it nevertheless blew up.”

An institutional investor considering making allocations to absolute return strategies via managed accounts should consider whether it has sufficient governance resources to benefit from the closer relationship with the manager and the manager’s strategy.

“Some investors are thinking twice about whether they really want all this information. Do they have the wherewithal in-house to monitor it?” asks Mr Cornish.

Another issue to consider is that this touted panacea for the woes of hedge fund investors is not a single, simple model. Like many things in the hedge fund world, the term managed account can mean a range of things, from a simple segregated mandate to an arrangement whereby a managed account platform provider takes care of custody, administration, client reporting – everything but the investment management.

“Managed account means different things to different people,” says Edgar Senior, global head of capital services at Credit Suisse. “It’s going through a really rapid product development period.” At the moment, he says, there is a full spectrum on offer, from the simple ad hoc account to the full service platform as offered by the likes of Lyxor and Casam (Crédit Agricole Structured Asset Management), and everything in between.

“It’s evolving in 20 different directions,” he says. According to evolutionary theory, this explosion of options is likely to be thinned out by natural selection, and Mr Senior’s expectations for the future of managed accounts are in line with this.

He predicts three models will survive: the most established being the big open architecture managed account platforms, which provide administration and custody, effectively providing an additional level of fiduciary oversight. This is appropriate for medium-sized investors who can afford to pay the extra administrative fees this entails, but do not want to invest in internal governance resources.

Larger investors – Mr Senior cites Calpers, the Californian public workers pension scheme – may prefer to set up their own, investor-driven managed account platforms, which could offer cost savings in two ways. First, they could negotiate with managers and administrators as to what level of service or transparency they want: daily calculations of net asset value might mean a high level of transparency but can be very expensive. With administrators, they would also see the same economies of scale as with a multi-strategy hedge fund.

In another direction, large hedge fund managers may start to set up their own managed account platforms, offering clients access to segregated accounts of their in-house strategies only. “The ad hoc account is the inefficient one,” says Mr Senior. “I see that dying away.”

It is not only investors who are looking at managed accounts. Intermediaries such as funds of hedge funds and private banks are also looking at the possibility, as they struggle to think of ways to convince clients to trust them.

“There are a lot of intermediaries out there who need a new and clean approach to continue to raise capital,” says Mr Senior.

Peter O’Dwyer, a director at Trinity Fund Administration, a specialist hedge fund administrator, agrees a lot of investors are considering managed accounts, but sees a lot of pitfalls.

He points out that many managed accounts can own funds, so the “adjacency issues”, such as liquidity, stops on redemption, and so on, that soured investors on the fund structure originally may not be avoided entirely.

The consensus seems to be the large, sophisticated investor will benefit from the recent increased willingness of under-pressure hedge fund managers to offer managed accounts, but many investors would do better to look to another way of accessing absolute return strategies.

“If liquidity and transparency are what you want, Ucits funds may be easier to use,” says Mr Senior.