Managed Accounts … A Better Alternative
Managed Accounts offer the investor a highly compelling alternative to investing directly in hedge funds.
Investing directly in hedge funds is a relatively simple and straightforward process. An investor only has fill out the subscription documents and wire in their capital to be invested.
However a direct hedge funds investment also comes with a number of flaws and potential risks. A fund investment can be illiquid, often subjecting the investor to lengthy lock-ups. If the manager underperforms or fails to live up to expectations, the investor can do little but sit and watch and wait for the redemption window to open up. An investor often has extremely limited transparency to the actual activity occurring within the funds, including the investments made and risks being taken. Along with limited transparency comes the opportunity for style drift if the manager decides to chase investment opportunities or undertake risks outside their core strategy or the mandates promised the investors. Additionally, the manager has the ability to pass costs and expense through the fund that could be unnecessary or unreasonable. And, the investor has very little recourse and almost no control over their investment, as they will give up rights, agree to a broad (and often very general) set of terms, and even indemnify the fund manager from liabilities.
A Better Alternative
Managed accounts, on the other hand, provide a means of investing in a manager through an account effectively owned and controlled by the investor. The investor has complete control over the investment. They have virtually immediate liquidity. If dissatisfied with the manager’s performance or other aspects of their business, an investor can terminate the investment at any time. The investor has complete transparency to the account and can see, in almost real time, the investments being made, the positions held, and the risks being undertaken. If the manager begins to drift from their promised strategy or expected risk profile, the investor has the ability to address and remedy almost immediately. The investor controls all fees and expenses paid by their account and has the right to refuse anything they deem unreasonable or not essential. And, in the case of the managed account, the manager is the one giving up rights and control, agreeing to the terms and parameters established by the investor.
There are other compelling advantages to investing via a managed account:
The investor can typically negotiate much better fees than they could investing directly in a fund. There are a few reasons for this. A managed account investment is usually much larger in scale than a fund investment, and the investor should be rewarded for that. The investor should also be rewarded for backing an emerging manager with an early investment.
The investor, directly or through a service provider, has the ability to value all positions held in the account, calculate the actual performance, calculate the fees of the account, including the fees earned by the manager, and make the ultimate payments. It is virtually impossible for fraud or embezzlement to occur in a managed account.
The investor can substantially leverage up their invested capital. The investor can take advantage of margin facilities provided by the prime brokers and leverage up their invested capital two, three or even more times. The cost of these leverage facilities is typically much lower than borrowing funds from a bank as there are economic advantages achieved by the prime brokers. Additionally, a structure where short rebates are netted across accounts could minimize the investment fees paid to managers, bringing down the effective cost structure.
The costs related to a managed account can be materially lower than the costs paid (indirectly) for a hedge fund. The managed account can achieve significant economies of scale with service providers by allocating costs across a number of accounts. The managed account investor can be more selective with the service providers, as they are often less concerned about the prestige of a service provider, and more focused on the cost. As indicated earlier, the managed account may deny certain expense that they believe to be unnecessary or unreasonable, something that cannot be one at the fund. Additionally, the managed account may not need to pay many of the expenses paid by a hedge fund, such as legal formation expenses, regulatory fees, and audit costs. (These alone can easily add to 1% or more.)
The investor now has better tools and resources to understand their overall risks (across all their investment) in real time and take the necessary action to manage the risks. The investor can evaluate their aggregate holdings and ascertain their true exposures across names, industries, regions, and even style factors. They will also have the tools to “stress-test” the portfolio to see how it could react during certain periods of market shocks. The investor will now be able to take immediate action to remedy any undesirable risks, either by reallocating capital across managers, placing restrictions on managers, or even investing in hedge overlays.
You Need Talent
However, setting up and investing via managed accounts is relatively complicated and challenging. Establishing the managed account demands an understanding of legal structures, critical service providers, and the necessary technology. Running the managed account requires unique experience and resources.
Establishing the managed account entails forming the ideal legal structure to facilitate the desired activity, selecting the critical service providers and negotiating the engagements, implementing the right systems to monitor the portfolios, evaluating risk and allocating capital. All these aspects will be unique to the needs of the investor, the types of investments they anticipate making, and the depth and degree to which they engage in the investing activity. All these factors will determine the “optimal” structure and dictate the costs of establishing and running the business.
Some platforms and established options may not satisfy the investor’s needs, or simply provide far more than the investor requires — in both cases unnecessarily costing the investor more than it should. Other structures may promise the perfect solution, only to disappoint the investors with functionality that’s too complicated, or functionality that comes short on expectations. Having the right partner who understands the investor’s needs and tailors the platform specific to these objectives, selecting the best structure and the best service providers, while being thoughtful to the costs of the platform will be paramount. Whether the needs of the investor are complicated and demanding or simple and fluid, there is no need for the investor to settle for a partner that fails to deliver.
Running the managed account is, in itself, a complicated and demanding business. All the compelling benefits and advantages are results of the unique structures and the engagement of the investor. But to derive these benefits, the investor must get the business right. The investor requires expertise and know-how. A managed account platform has a myriad of operational obligations: financial and tax, investment operations, compliance, risk management, portfolio construction, and manager due diligence. Whether these obligations are handled internally, or outsourced to third parties, the investor needs a partner who recognizes and understands these obligations, a partner who has the experience and the expertise and access to the right solutions.
Prizm Advisory
With almost three decades experience launching and running complex and compelling investment organizations in demanding and rapidly evolving markets, Prizm Advisory brings unparalleled experience and expertise to our partners. With talent that covers the many facets and competencies of the investment organization, Prizm Advisory possesses a unique blend of insights and proficiency in all aspects of investment management, including operations, accounting and finance, legal and compliance, quantitative analytics, technology and infrastructure, operational due diligence and risk management.
Prizm Advisory advises our partners in establishing their investment organizations, formulating business plans and executable strategies, determining the appropriate legal structures, selecting and negotiating service providers, implementing systems and controls, recruiting critical talent, handling legal and regulatory needs, and developing risk controls. The engagements vary on the specific situations and exact needs of the clients. Based on the investment team’s unique expertise and investment philosophy, Prizm Advisory will build a platform that delivers genuine value and tangible benefits to the investor.
Prizm Advisory provides outsourced oversight of the businesses. Prizm Advisory will handle every functional need of the organization. Prizm Advisory will serve as the outsourced Chief Financial Officer, and where necessary, the Chief Operating Officer and the Chief Compliance Officer. Based on the specific needs of the investors and the unique nature of every managed account and allocation style, Prizm Advisory will provide the exact support and services the investor requires, at a cost structure that does not undermine the value proposition.
Prizm Advisory supports our partners in the selection, the due diligence, and the oversight of the portfolio managers they invest in. From analyzing the individual investment strategies and evaluating the investment risks, to ascertaining the value proposition to the investor’s overall portfolio, and conducting thorough due diligence on the investment managers, Prizm Advisory will provide the tools and insights the investors can rely on for effective manager selection and portfolio allocation.
An added level of value Prizm Advisory can offer is the expertise and guidance to the exact managers our partners are investing in. There is always an elevated degree of risk investing with small or emerging managers, simply because they may lack the resources and experience to invest in the best services or system or make the most prudent decisions. This brings a potential for economic and reputational risks. With Prizm Advisory in the engagement, we will provide guidance and services to ensure the many operational and investment risks have been mitigated.
For those institutional clients, such as family offices and funds-of-funds, that have aspirations of offering their product to a broader base of clients, Prizm Advisory will provide support with capital raising and investor relations. From developing a compelling narrative and preparing marketing materials, to identifying and engaging with prospective investors, Prizm Advisory will help our partners grow their businesses and attain their organizational ambitions.
For additional information or to discuss how Prizm Advisory can help you, please contact Michael Lubman, michael@prizmalpha.com or +1 917.518.7745.
