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.
However, financial risks such as leverage are not the
biggest issue for hedge fund investors, according to Antoine Broquereau, who as
head of structuring and Alternative Investment Solutions at Société Générale
Corporate & Investment Banking, is in charge of Lyxor. In fact, according to Broquereau, most hedge
fund debacles are caused by non-financial risks, particularly operational
risks arising from the unregulated nature of hedge funds. “One of the main issues is that hedge funds
are often referred to as ‘black boxes’ due to the lack of regulation or
transparency.
Using the managed account is a way to cope with that because you
hand over the operational risk management function to a third party who makes
sure that settlements are correctly done, that the net asset value is computed
correctly without relying on the manager as a source of pricing, that the position
is reconciled between the auditor, manager, prime brokers and Lyxor,”
Broquereau says. “You are effectively multiplying the number of ‘actors’ in the
chain to make sure that independence from the manager is guaranteed.
The
transparency tells you what the manager is doing, whether he is leveraged,
whether he is using all the limits given to him, and whether he is changing the
strategy,” he notes. Fraudulent activities, the dangers of which were
highlighted by the Bernard Madoff case, have made it even more pertinent that
investors are able to monitor their exposures closely, understand the strategy
of the manager, and are able to get access to underlying funds managers on a
regular basis, Broquereau argues. “In
the Madoff case, there were a lot of links between the manager, the prime
broker and administrator of the fund.
By breaking up such links through the use
of a managed account, you make sure there is no conflict of interest between
the different activities,” Broquereau says. The additional risk controls meant
the Lyxor funds dodged a bullet not only on Madoff, but on the collapse of
major prime brokers Bear Sterns and Lehman Brothers. As the credit spreads for
each bank ratcheted up in the days before their demise, Lyxor withdrew accounts
with them accordingly.
The man
responsible for marketing Lyxor’s managed account-based hedge funds-of-funds
in Australia,
Paul Stevenson, admits the managed account structure creates extra work for
individual hedge funds, and a hurdle for potential investors facing stricter
fee budgets. Managers have also expressed concerns that running managed
accounts alongside their traditional unit trusts creates a privileged class of
investors, in that the managed account owner can withdraw their funds whenever
they want, potentially increasing illiquidity for those trust investors exposed
to the same positions. However, the fact that managers aren’t willing to go on
the record saying anything disparaging about managed accounts is a sign of
their new supremacy among wary institutional investors.
Stevenson points out any misgivings have not
stopped prestigious names like Bridgewater,
Winton Capital and the Paulson funds maintaining managed accounts with the
Paris-based firm. One fact working in the Lyxor managed account product’s
favour is that it honoured all termination requests as investors scoured for
liquid assets during 2008.
This has become a big differentiator in the market,
given so many hedge funds imposed gates late last year, Stevenson says. “We are
currently working with managers who trade highly liquid instruments,”
Broquereau says, pointing to weekly liquidity as the preferred policy. “We
would consider less liquid strategies but we’ll have to make sure we can
analyse and value the strategies.”
