Clients know that managed accounts (MACs) offer a number of important potential advantages compared to commingled funds. One of the key advantages often cited is transparency. With a MAC structure, clients are set up to directly view the assets in the trading accounts to help better ensure that the correct strategy is being followed and monitor items such as risk limits or liquidity.
Yet, we think operating a successful MAC platform involves a lot more than just providing transparency. In particular, we believe the ability to customise these MACs is valuable since it permits the provision of investment profiles that may be more suited to each client’s requirements.
However, one important factor that is sometimes overlooked is the ability to potentially influence and exercise more control over certain areas of the investment process. Such control may be vital to some investors and can potentially be exercised in tangible ways, such as the ability to more closely control fees, but also more subtle ways, such as control of legal agreements, MAC structure or service providers. All of these factors are important in assisting clients achieve costs savings on their hedge fund investments.
In the current market environment, clients understandably are acutely cost conscious. In any exercise to reduce the costs related to investment management, the obvious place to start is fees.
Performance and management fees
There are good reasons why the hedge fund manager of a MAC may provide lower fees. There are, for example, some ways in which an investment manager may provide less service to a MAC than to their commingled fund. For the hedge fund manager of a MAC, there is no operational oversight of service providers or legal documents (as these are provided by the MAC platform), and no marketing expense; it is thus reasonable to request lower fees for the MAC client.
In our opinion, lower fees in MACs versus a manager’s commingled fund can be achieved where the MAC provider has the scale, expertise and reputation as an established, quality hedge fund investor.
Size and scale: The size of a MAC provider in bringing scale and alternative investment industry experience has a significant bearing on negotiating lower fees with a manager. When a significant MAC provider allocates to new managers either on its own behalf or on behalf of their clients, they will generally do so in size.
Expertise and experience: Having a significant number of years’ experience in constructing and investing in MACs across all hedge fund strategies means that the launch process for that hedge fund manager is simplified despite the complexity of some hedge fund strategies such as event-driven strategies. The valuable experience gained from implementing highly liquid to less liquid strategies means that hedge fund managers are more likely to negotiate their terms and conditions on the MACs versus their reference funds.
Reputation: Being a well-regarded and respected investor generally makes the MAC provider a more attractive proposition to most hedge funds. Having an established reputation often provides opportunities for the MAC provider to set up MACs on terms that are more beneficial to clients than would normally be available in the commingled fund vehicle. Many managers know that infrastructure and experience of the MAC provider will more likely result in less operational burden for them, since the MAC provider takes on work that the manager would otherwise be doing for their reference fund. This can also help achieve discounts to fees which, once again, should transparently flow directly to the end client.
Controlling other costs
There are also a number of additional areas where MACs can provide greater control and help reduce costs to clients.
The most obvious area of expenditure beyond headline fees is the cost of service providers. Since service providers are contracted directly to the managed account vehicle, the firm managing the vehicle can actively negotiate the most appropriate service levels and fees. Hence considerable savings can potentially be made through the negotiation of administrator and broker fees as well as audit and legal costs.
As with headline fees, experience and scale can also play an important part in being able to gain the best possible terms with service providers for clients. Having the ability to select from an extensive number of service providers including administrators, prime brokers and Isda counterparties (rather than being confined to a small set menu of service providers) means that the MAC provider can potentially provide an open “architecture” platform to their clients. This open architecture approach can help enable the MAC to better mirror the trading set up of each investment manager which may reduce the often hidden cost of investment slippage.
Other control considerations
There are also other areas where cost factors may be less tangible or hidden, but still significant. For example, negotiating trading agreements with prime brokers, Isdas or clearers can lead to improved terms for a MAC, such as helping ensure more favourable treatment of collateral or margin. Similarly, the ability to set up an optimal fund structure for each MAC can help lead to reduced total costs for clients by ensuring that they are able to access the investments more easily, making feeder structures unnecessary.
Identifying the most appropriate MAC provider and partner is crucial for hedge fund clients who are looking to keep their MAC setup costs to a minimum. Clients should be able to draw on the MAC providers’ well resourced, experienced in-house teams to control and minimise costs such as external legal counsel as these costs are charged to the MAC itself. These costs, particularly, in specialist areas, can substantively increase depending on the strategy being implemented and the number of counterparties (such as prime brokers) involved in the MAC.
Finally, there is the fine detail of how the manager sets up the account operationally that can influence overall performance and potentially reduce costs. Careful attention to operational due diligence can help ensure that important items like unfair trade allocation does not detract from potential performance for clients.
We have highlighted how using a MAC to allocate to hedge funds can help give a client greater ability to influence costs and investment conditions. In comparison, the ability to influence these factors with a commingled fund allocation is often quite limited.
FRM’s experience suggests that utilising MACs offers potential opportunities to reduce costs and improve the terms of a hedge fund investment. However, the selection of the right MAC provider is crucial to clients in achieving this.