The challenges and best practices of managed account relationships drew a capacity audience of hedge fund investors and managers, representing approximately $260 billion in assets under management (AUM), to a recent GlobeOp-hosted seminar in New York City.
A panel of established experts from a cross-section of the industry addressed the key considerations of manager selection, legal requirements, middle-back office services, controls and monitoring.
Speakers representing Lighthouse Investment Partners, Lyxor Asset Management, Waterstone Capital Management, Bracewell & Giuliani, Newedge Group and GlobeOp offered the following insights:
“We transitioned to managed accounts over the last five years for the added benefits of transparency, flexibility, and control, says Sean McGould, president and co-chief investment officer, Lighthouse Partners. Full transparency allows for a deeper focus than has traditionally been the case, especially during the manager selection process. For prospective managers, there are three primary considerations. First, does the manager offer real diversification or do they merely compound existing risks? This can only be accurately measured by layering a prospect’s daily position level data into the portfolio and conducting a deep statistical analysis. Second, is the portfolio highly correlated to the most widely held names or other dominant themes within the hedge fund universe? Having the ability to confirm the uniqueness of a prospect’s portfolio is of great benefit and increases the level of overall diversification. Finally, if the manager meets these tests, is there a willingness to commit the resources necessary to make a managed account feasible and the on-boarding process as seamless as possible? …Flexibility is key to remaining opportunistic and taking advantage of market dislocations. …The benefit of control speaks for itself after a year like 2008.
“The two main risks for investors are market risk and operations risk – one to manage and the other to mitigate… says Nathanael Benzaken, managing director, Lyxor Asset Management The challenge with transparency is how to exploit it. To understand risk, investors need robust software, experienced risk managers, and an appropriate risk methodology. Only scenario and stress test models can help assess tail risk in dislocated markets. VaR is not appropriate, unless perhaps for manager-level portfolio construction… The managed account’s segregation facilitates operational risk management. This is the most important risk to eliminate because it creates a short put equivalent position for investors – it’s the ‘dark side’…. All managed accounts and platforms are not equal. Some are ‘Madoff-able;’ some are ‘Amaranth-able.’ For full transparency and to identify risk and/or style drift early, in-depth and regular due diligence should be done on the underlying managers, the platform structure and infrastructure – at inception and throughout the life of the relationships.
Risk monitoring is nothing, what really matters is risk management. The goal is not to second- guess or intervene in portfolio management, but to understand and take clear action when it’s necessary – for instance in the case of mitigating counterparty risk or when confidence in the manager is lost (e.g. breach of mandate).”
Cost and resources also matter. Managed accounts are about data management. Operational systems are needed to create reporting transparency. Is there sufficient operational staff for trade allocation, valuation and settlement, portfolio accounting and programming? …It’s very difficult to run multiple funds without investing in technology. Trade allocations should be automated to mitigate manual intervention. … Investors also need resources to execute managed accounts – it requires two-three months, including the key challenges of the legal aspects and establishing prime broker accounts.”
D.C.