1. Maintain as much control over your assets as is reasonable. If you do not have control over your assets there should be very high operational due diligence hurdles. 2. Separate asset ownership from the portfolio managers’ control wherever possible to limit the risk of fraud. 3. Demand position level transparency from an independent source and employ appropriate third party risk management systems. Do not rely on the manager to provide this data.
4. Ensure the liquidity being offered is the liquidity of the underlying instruments. Don’t invest in vehicles that run a liquidity mismatch between underlying manager vehicles and their obligations to counterparties (e.g. FX hedging counterparties) or investors. 5. Avoid managers/strategies that employ too much leverage. These have blown up in the past and are likely to blow up again in the future. 6. Invest in exchange traded instruments wherever possible as this mitigates counterparty risk.
7. Pay fees that are reasonable, appropriate and commensurate with the managers’ skill and re-investment into research. 8. Align the risks of the investment with the remuneration of the manager. There is little sense in paying away 20 per cent of the upside but assuming all of the downside as the investor. All of the above principles can be achieved via an investment in a managed account platform.
A managed account platform is one where the investor, rather than the manager, has the fiduciary control over the underlying investment positions created by the investment manager. This is identical to the use of a custodian account for most investors with traditional mandates. We believe managed account platforms will play an increasingly integral part of the solution for investors wanting to benefit from hedge fund investing, but have concerns over the key issues of transparency, control and fees.
After ten years of virtually a zero return from global equity markets, the investment community is gradually adapting to the shortcomings of the conventional approach of investing but are disappointed with their recent experiences of hedge funds. Resolving the structural flaws of hedge funds will be one important step forward in the chase for higher, more stable returns, and managed account platforms have an important role to play in achieving this outcome.