Managed accounts are costlier upfront for hedge fund investors than traditional unit trust structures. However, a war story from the start of the credit crisis illustrates that the structure may save an investor from catastrophic losses in the long run. In August 2007, Paris-based Capital Fund Management informed investors in its Discus managed futures fund that they faced big losses, because the firm with which Discus invested its left-over cash, Sentinel, had entered bankruptcy amid allegations of fraud. It took the Discus fund six months to recover the losses, and no doubt the angst caused to investors was longer-lasting.
However the Discus fund was also offered via a managed account platform, arranged by fellow Parisians Lyxor Asset Management, the hedge fund-of-funds subsidiary of Societe Generale. The managed account version had an MER which was 85 bps higher than the Discus unit trust, but it had no ties to Sentinel and was unaffected by that manager’s collapse. Indeed, Lyxor set up managed accounts in the late 1990s as a means by which it could get its parent’s agreement to run structured products and derivatives over its hedge fund-of-funds.
Societe Generale’s risk committee did not want the bank’s balance sheet guaranteeing the activities of external hedge fund unit trusts – activities beyond its control such as investing cash with Sentinel – so it made the development of structured products conditional on a model that allowed the bank to completely control the assets. Managed accounts are essentially hedge funds managed according to a mandate with defined investment guidelines and risk limits given by an independent manager – in this example, Lyxor. The managed accounts are established in the form of a limited liability company (LLC), and deposited with one or several independent prime brokers.
There is no link between the managed accounts and the original hedge funds, apart from the fact that they are managed according to the same strategy by the same funds managers. However the differences in the risk controls – such as more conservative leverage – can make for big differences in performance. Lyxor’s flagship 40-manager ‘Diversified Fund’, which is run on a managed account basis, returned negative 6.7 per cent in calendar 2008, against negative 21.37 per cent for HFRI’s Hedge Fund-of-fund Composite Index. This was partly because they were less leveraged to the negative beta produced by most markets last year – the same reason the fund has underperformed in 2009 to date, as markets rallied from March.