Managed Accounts- What You Need To Know

Recently I got an e-mail from a lawyer dealing with documenting fund of fund financing who wanted to know more about- Managed Accounts. I liked what I said, so here's a re-print w/ few exclusive additions.

Under the managed accounts platform, funds are invested in segregated accounts, each of which is managed according to a particular strategy by a ABC hedge fund manager within pre-defined limits.

The manager’s authority typically is a limited power of attorney that grants the manager the ability to place and liquidate trades, but not the ability to move cash into or out of the account or to link the account to any other account. A trust controlled by a custodian is one particularly effective means of protecting the account assets from any improper transfers or account linkages by the manager or any other party.

An external fund administrator is responsible for all hedge funds administration activities. The funds administrator (i.e.- Anson Group) interfaces with the prime brokers and receives information on trades and positions.

The funds administrator is then responsible for pricing all securities using independent sources such as Bloomberg, Reuters and independent market makers and for calculating the NAV of the managed accounts on a daily basis (for more complex positions like illiquid closed end funds or credit derivatives it's done on a weekly, maybe even bi-monthly basis). This approach provides investors with position-level transparency, performance monitoring, liquidity at NAV, tax efficient structures and flexible asset allocation.

Where/how it holds its assets?: Usually with the Prime Brokerage(s). The job of the funds admin is to monitor the positions and keep the investors abreast of the traits in italics above. For example- Amaranth was supposed to be a multi-strat HF, but they increased their bets in Nat Gas.

If there was a funds admin- they would have told investors "these guys are deviating from their strategy!" and the alarm bells would go off. Most FoFs, the good ones anyway, watch the aforementioned traits like a vulture eyeing its prey or a trader keeping tabs on his positions.

How subscriptions/redemptions work: Typically, it will take approximately a month or longer for hedge funds to return assets after the effective redemption rate. Moreover, many hedge funds will withhold 5-10% of the assets until the completion of the annual audit.

Many offering memorandums will allow for the implementation of a gate on the maximum amount of total investor redemptions during each redemption period. The purpose of a gate is to prevent unusually large redemptions from disrupting the portfolio.

If imposed, a gate will prevent investors from redeeming more than a minority of their holdings. The problem with a gate is that by definition it will be implemented precisely at those times when many investors want to redeem.

For example, if a fund witnesses an unexpectedly large loss, leading to many of its investors seeking to redeem, the imposition of a gate would significantly reduce the amount each investor could redeem.

The implementation of penalty charges for redemption during the first year of the investment are becoming increasingly widespread, and the amount of these penalties are increasing. It is now quite common to see funds specifying a penalty of 3%-5% for redemption during the first year. Moreover, many funds now impose penalties beyond the first year of investment as well.

The Major Advantages of a Managed Account:

1 ) Daily Transparency—A managed account allows for daily position level transparency and monitoring.

2) Daily Independent Pricing—A managed account makes it possible to independently price a portfolio daily.

3) Better Liquidity Terms—Managed accounts typically provide much more favorable liquidity terms than the counterpart funds. Monthly liquidity is the norm rather than the exception.

4) Control of Cash Movements—If structured properly, a managed account will prohibit the manager from any involvement regarding cash movements in or out of the account; the manager's sole responsibility is limited to the investment of the portfolio.

5) Insulation of Account from Fraudulent Linkages—The managed account will belong to the investor or a proxy for the investor—a structure that makes it impossible for an unscrupulous manager to fraudulently link the account to any other account without investor knowledge (recall the NFL dudes who were duped for millions?)

6) Minimal Lag between Liquidation of Investment and Return of Cash—In a managed account, funds are normally returned promptly upon redemption, in contrast to the approximate month or longer delay that is common in hedge funds. There are also no audit holdbacks for managed accounts.

7) Accounts Can Be Customized to Minimize Assets Held in Cash—Many hedge fund strategies utilize only a fraction of their assets under management to meet margin requirements. Managed accounts can be structured to be more cash efficient.

8) Portfolio Exposure Information—Position level transparency allows for estimating the exposure sensitivity of a portfolio to a range of market factors and conducting stress tests for various events.

Major Drawback

Managed Accounts are being utilized mostly by second, third-tier managers who find it necessary to disclose as much as possible to attract investment dollars. If you look at the most notable hedge fund launches, Jabre Capital Partners to Carlyle Group's Hedge Funds, they are not managed accounts, far from it.

Partly because the best hedge funds are self-regulated in a way no regulations can comprehend of doing. After all, you don't reach the ranks of consistent, double digit returns without excellent risk management policies.