Controlling risk through managed account
Can be simple stand-alone master funds or can grow to include several special purpose vehicles
The pros and cons of MACs
Increasing demand for transparency into, and control over, hedge fund allocations is likely to drive demand for managed accounts. A managed account (MAC) is an investment structure that is owned or controlled by the investor but typically mirrors the strategy of an existing hedge fund.
A robust MAC will typically include an independent board of directors and a network of contractual relationships between the MAC and its trading counterparties and service providers.
MACs can be simple stand-alone master funds, or can grow to include several special purpose vehicles (SPVs) and feeders to accommodate bespoke (customised) trading and tax issues in various jurisdictions. While MAC structures differ from investor to investor, the central premise remains the same: investors can benefit from additional control and transparency.
The investment manager agrees commercial and legal terms with the MAC. Managers are responsible for trading the strategy within the agreed terms.
Key benefits
The key benefits to the investor can be:
- Position level transparency available on a daily, weekly or monthly basis (particularly important to institutions looking to manage their exposure across multiple portfolios)
- Ability to customise investment and risk guidelines
- Operational control
- Counterparty and service provider selection
- Enhanced risk and cash management
- Segregated assets — no cross liability with other entities
- Assets are placed in approved custodian accounts and in the investor's name
In short, investors gain the ability to tailor their investment programme and receive enhanced liquidity. In addition, they can have the ability to adjust leverage, change the liquidity profile of the investment and adjust instruments and trades as agreed between the parties. Investors also gain additional business and risk transparency because they should have direct contact with all service providers and counterparties
MACs do, however, have some limitations. For a start, a MAC structure can add between 50 to 100 basis points to the cost of investing in hedge funds as they may demand increased services to manage daily data. This charge is typically netted from performance.
MACs can also present operational and relationship challenges with the hedge fund managers. Extra resources and effort required by a manager to integrate properly with a potentially new service provider can be demanding. The working relationship between some managers and service providers can be complex as ultimate ownership of the relationship with these service providers rests with the managed account rather than the manager.
Nor are MACs suitable for all trading strategies. Accurate data is difficult to collect on a daily basis and may not be particularly useful from certain hedge funds, such as event driven managers that trade in highly illiquid markets, complicated instruments and hard to price assets.
Managed futures
To clarify, if there is a gap between the underlying assets in the account and the investor's ability to interpret and act upon the data, the cost of the MAC may outweigh the benefit.
As a result, MACs tend to be concentrated in managed futures, long/short equities and other exchange traded strategies that are simpler to operate and manage from an administrative perspective and which allow investors to take advantage of liquidity options.
MACs also require a great deal of administration and monitoring. It is critical that an investor has the know-how and resources to set up and operate the managed account in a way that does not divert the manager from the business of trading.
There are resource limits to the number of MACs a manager can effectively operate and it is important for hedge funds to partner with investors who have the right expertise — this often means those at the larger end of the spectrum.
Finally, there is an open question as to the benefits of position level transparency. The amount of data can be overwhelming and many question investors' ability to interpret the data appropriately. Investors hire hedge funds to make investment decisions on their behalf, so creating a mechanism ‘to manage the manager' is potentially counterproductive.
Nevertheless, MACs are powerful instruments of active management, giving professional investors the tools to upgrade their control of risk, returns and the dynamics of allocation, as well as providing important mechanisms to monitor and mitigate operational risk.
Not for everybody
They may not be for everybody, or useful for all strategies, but for users with the resources and know-how to keep pace with the changes and who can ‘read' and understand the powerful data streams they furnish, MACs provide an alternative and potentially powerful route to accessing the expertise of hedge fund managers.
The writer is CEO of Man Investments Middle East. The views expressed here are his own and do not reflect those of Gulf News.
