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Investors warming up to managed accounts

Bruce Keith
Bruce Keith thinks managed account allocations are increasing.

Updated with correction

The use of managed accounts is on the rise as institutional investors batten down the hatches on their hedge fund portfolios in the face of widespread criticism of fees, returns and transparency.

More large institutional hedge fund investors than ever are searching for managed account investment platforms and advice about how to move both new and existing hedge fund investments into vehicles that make them the sole investor with full control over the separate account, sources said.

Other advantages of managed accounts are significantly lower fees, ready customization of a hedge fund manager's strategy, daily valuation and full transparency of portfolio holdings.

The Alaska Permanent Fund Corp., Juneau, is redeeming its $2 billion in hedge funds of funds as part of a move to bring all hedge fund decisions in-house. Investment officials at the $53 billion sovereign wealth fund already have invested $3 billion directly in hedge funds and intend to increase the target to $5.9 billion from $5.4 billion.

The fund's investment staff is considering a move to a managed account format, said two industry sources with knowledge of APF's plans who asked not to be identified. Marcus Frampton, director of private markets for the fund, did not return a call seeking confirmation.

The $28.2 billion Iowa Public Employees' Retirement System, Des Moines, soon will begin negotiating managed and separate accounts with seven firms, including hedge fund managers AQR Capital Management LLC, Graham Capital LP and Lynx Asset Management AB, to implement a $700 million (notional value) absolute-return strategy portfolio, said Karl Koch, chief investment officer, in a statement.

The $188.8 billion California State Teachers' Retirement System, West Sacramento, is evaluating money managers to run its new $16 billion risk-mitigating strategies portfolio, and has a preference for using managed accounts for global macro and managed futures investment strategies, said Ricardo Duran, a spokesman, in an e-mail.

Catalogued the features

CalSTRS' investment officials catalogued the features they most appreciate about managed accounts in a report prepared for a Feb. 3 investment committee meeting:

nfull transparency on managers' portfolio positions and ability to compare managers following the same strategy;

ncontrol over excessive risk taking, manager style drift, leverage, exposure policies and liquidity risks through agreed risk management guidelines;

nprotection against fraud, misappropriation of assets and misrepresentation of performance;

n negotiation of terms for strategy customization, investment guidelines, management and performance fees, and fee reporting; and

nreducing cost of services from non-investment oriented providers, including custodians, administrators and auditors, because of the scale offered by a standardized managed account platform.

Managed account platform providers report steady growth in inflows from institutional investors over the last several years, but stress that 2016 represents a pivotal point as pension fund, endowment, foundation and sovereign wealth fund trustees seek reassurance that hedge fund allocations are essential to the investment success of their asset pools.

“We're starting to see a pickup in interest in managed accounts which parallels negative press reports about hedge funds. Institutional investors need to justify why hedge funds fit into their portfolio and high fees. The pipeline of institutional RFPs ... is growing,” said Andrew S. Lapkin, CEO of HedgeMark International LLC, New York, which offers managed account services.

HedgeMark has seen a 203% increase in total assets on its platformto $8.8 billion in the two years ended Dec. 31. Dedicated managed account assets rose 253% to $3.4 billion in the period and accounted for 39% of 2015 total year-end assets. Liquid alternative managed account assets rose 177% in the same period, accounting for 61% of assets, according to data from HedgeMark. HedgeMark's platform was launched in 2012.

Bruce Keith, CEO of managed account platform provider Infrahedge Ltd., London, agreed that “if you look beyond the headlines, you'll see that many institutional investors are considering a move to managed accounts” in response to “governance requests from boards (of trustees) that are supportive of hedge fund investment but want to be sure that investment staff have both control and visibility — line-of-sight transparency — into hedge fund portfolio holdings.”

The highest volume of transfers into managed accounts is coming from North American institutions, Mr. Keith said, noting the most interesting part of the wave of inflows is the greater size of individual allocations, with more investments starting at $200 million per hedge fund manager than in the past.

“There is definitely appetite for managed accounts, especially if you have a lot of money to put to work,” said Peter Dom, managing director and founder of AF Advisors BV, Rotterdam, Netherlands, a consulting firm that specializes in advising institutional investors on the structure of managed account programs.

In fact allocation size — generally at least $75 million and more likely between $100 million and $300 million — is the most important determinant for a hedge fund managed account, sources said.

As with allocations to long-only active investment strategies, the larger the allocation, the more willing a hedge fund manager will be to drop fees below the 2% management fee/20% performance fee standard.

“If you bring between $100 million and $300 million to a hedge fund manager for a managed account, it's fair to get a better deal on pricing, but it can't be so low that it's not a win-win for the manager too,” Mr. Dom said.

Part of the fairness of a managed account structure is that the hedge fund manager can't charge non-investment operating expenses such as marketing or technology costs to the owner the way it can with a commingled fund, added Mr. Dom.

Other sources said that the overall blended savings negotiated for management and performance fees easily covers the cost for asset owners investing in hedge funds via a managed account platform, which ranges between 15 and 30 basis points per account, depending on the strategy and the hedge fund manager.

Costs covered

By way of a real-life example, the $60.4 billion Massachusetts Pension Reserves Investment Management Board, Boston, has saved between 40% and 50% on blended management and performance fees with managed accounts vs. a commingled hedge fund, said Eric Nierenberg, senior investment officer and director of hedge funds and low-volatility strategies.

“We get very, very substantial fee reductions off the rack rate” with managed accounts, Mr. Nierenberg stressed, in addition to much better liquidity terms, direct control of assets, a high degree of strategy customization and full transparency, which is “crucial for managing and monitoring risk.” In fact, Mr. Nierenberg, something of a self-professed “quant geek,” runs the portfolios of PRIM's managed account hedge fund portfolios through the fund's risk systems every day, and that yields “extremely enlightening” results, he said.

PRIM began to move to managed accounts for all new hedge fund investments about 18 months ago and now has about 30% of its $5 billion hedge fund portfolio in the new vehicles. Some of PRIM's older commingled investments also were converted to managed accounts, and the plan is to move the majority of hedge fund investments in the portfolio to managed accounts over time, Mr. Nierenberg said.

Investment officers haven't been able to convince all of PRIM's existing hedge fund managers to move to managed accounts — “if you're a $50 billion hedge fund manager with good returns, you don't have to offer managed accounts,” Mr. Nierenberg said — but he added that he's seen big changes in the past two years.

“The landscape has definitely changed. There are managers who two years ago wouldn't consider a managed account who are coming back to talk to us about making a change,” he said.

Given the rough treatment hedge funds are getting from many quarters combined with challenging investment conditions, all but the best “hedge funds have to get off their thrones and get down on their knees to get investors to give them their money,” preferably via a managed account, quipped AF Advisors' Mr. Dom. n

This article originally appeared in the July 11, 2016 print issue as, "Investors warming up to managed accounts".