Separately Managed Accounts - Blessing or Curse? Part 1

More than ever, I am seeing investors utilize separately managed accounts as opposed to direct hedge fund investments.  The question however remains, is this a benefit for hedge fund managers, or will it lead to the death of the traditional hedge fund structure?

First, for those unfamiliar with the term 'separately managed accounts' (SMA), an SMA is basically a brokerage account that is held in the investor's name as opposed to the fund's name, and is not intertwined or co-mingled in any way with the fund (separate).   The fund manager is typically the 'sub-advisor' for the account, and has limited power to simply trade the account, and not make any withdrawals or money transfers.  The sub-advisors are typically paid on a quarterly basis (a bonus for fund managers that normally take fees annually) and usually get paid the same fees they would with their hedge fund.  The SMA is typically traded the exact same way as the hedge fund, with no time or selection bias, essentially Parri-Passu (hand in hand/equal footing) if the strategy allows.   There are certain strategies where this is simply impossible, and therefore SMA's are simply not appropriate and fund investments or pooled vehicles are the only proper way to allocate and diversify the portfolio.

Now that we understand what an separately managed account is, let's talk about the benefits.  Assume strategy permits SMA's of course.

For the investor, utilizing SMA's is a much more effective method of allocating.  SMA's allow the investor benefits like:
  • Transparency
  • Liquidity
  • Decreased Costs (no admin/audit/other fees bringing down returns)
  • Ability to properly weight their overall portfolios
  • Ability to individually leverage accounts and tweak exposure
  • Choice of custodian 
  • Control over commission/finance costs 
  • Prohibit/Severely Inhibit fraud from occurring
These benefits are huge in my opinion.  An investor can shut a manager down and liquidate their account at anytime if they see things like position concentration or 'style drift'.  They can utilize software to monitor all their accounts at one time and quantitative tools that help them effectively manage their risk moment by moment.  They can use notional exposure from one account to fund another and actually (for once) get back the ability to leverage their hedge fund holdings. (key for fund of funds, a dying breed that needs any edge possible to produce additional alpha) Investor's can hire their own administrators if they even deem them necessary, and not have to share in expensive audit bills. They can't steal any money from the account, OR post fake returns, because the investor gets all the statements! I can keep going....

Obviously all these factors are compelling reasons to invest via SMA, but of course, there usually is a catch.  In this case, the catch is often that in order to obtain a managed account from an established fund manager, you have to have a minimum investment of anywhere from five to fifty million dollars.  So, as amazing as the benefits of an SMA structure are as opposed to a traditional fund investment, usually only the institutional or super wealthy family office types are able to meet the minimums required to establish the accounts.

I will continue with the potential problems for an investor with the SMA structure and why the structure will not work for all products in my next post.  In addition, I will discuss the benefits/caveats for fund managers that allow the use of SMA's, and I will conclude with whether I think SMA's will be death of the traditional fund investment, or instead be the tool that helps bring trillions of additional capital into alternative investment managers coffers.  

Quick housekeeping item, I have been away from writing on the blog for far too long!  When I started writing my capital introduction blog the hedge fund marketing/capital introduction industry was still thawing, and so it gave me some time to express my thoughts and share my experience with the public.  However as an active marketer and manager one of the larger capital introduction teams in the industry, once the ice did thaw, we found there were still plenty of sweet smelling flowers available underneath.  As a result, myself and my team have been extremely busy raising assets almost exclusively for emerging managers over the past year, and I am proud to say from experience that money has definitely returned to the alternative space.  We have had tremendous success over the past year and as a result, it has severely impacted the time I had available to write on Cap Intro blog.  That said, I am making a conscious effort to try to write at least a few entries a week going forward.  I have a ton of new topics that have been bouncing around in my head for months that I must share.  So get ready for some new entries shortly and thanks for your patience and continued reading and following of www.capitalintroduction.com.

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