Following the liquidity crisis of 2008, institutional investors are turning to managed account platforms as an alternative to direct investment. Hedge fund managers also see advantages in joining MAPs.

Managed account platforms are entering a second stage of development. The focus has moved away from liquidity and onto the value added by having a sound operational and risk management support structure.

This is driven by an expanding investor base to include very large institutional investors whose investment horizon is long, requiring less frequent liquidity but more a robust infrastructure. As a consequence of this broadening investor base, managers have fast realised the importance of having a platform offering. It is now seen and accepted as a way to gain maximum possible exposure and a useful secondary asset base.

“The focus on liquidity that was so evident in 2008 has now shifted. Then managed accounts were seen as a safer option due to their liquidity. But since then offshore funds have improved their liquidity and investors have more choice if liquidity is their main concern,” says Soobong Han, product manager for the managed platform at BNP Paribas.

Some of the more established managed account platforms were set up initially to support a bank’s own structured product offering. The main purpose behind their creation was to manage the bank’s own risks and exposures as well as to offer a range of products to clients.

This practice eventually dovetailed with the perception that hedge funds needed a structured platform to support them in order to attract a different set of investors and for those who wanted more control around their investment, including risk management as well as liquidity.

With the financial crisis in 2008, many investors were unable to redeem their investments in hedge funds. What followed was a near-obsessive concern over liquidity with investors and managers alike placing increased importance on liquidity terms. According to Martin Fothergill, global head of managed accounts at Deutsche Bank X-markets, some hedge funds with large illiquid holdings, for example private equity and real estate, took the decision to trade a more liquid strategy. Although being suitable for a platform was not the aim, it was certainly a byproduct of the trend. At the same time many managers who had previously refused to look twice at the idea of managed accounts became more open to the concept as a way to build an asset base heavily damaged by the crisis as well as way to attract new investors.

Ken Phillips, CEO at Hedgemark, thinks however the emphasis on liquidity by both sides is misplaced. “The notion that hedge funds do not allow for good governance and thus need a platform is a relatively new notion,” he says. “I think it is more the case that some investors don’t have the in-depth understanding of the various legal structures that support hedge funds and the nuances between them and so seek to make a value proposition based around liquidity.”

Phillips says the actual value of a platform is to provide risk and operational management and adopt an honest approach to liquidity by not forcing a strategy that is inherently unsuited to frequent liquidity onto a platform that boasts weekly liquidity, for example.

“Deliverables, the integrity of the platform, the power of the platform to attract managers and quality distribution networks, critical mass and operational integrity are far more important than offering uniform liquidity,” he says.

These deliverables are taking on more importance as the investor base of platforms changes to include increasingly large institutional investors. Such investors tend to have longer investment horizons and are inherently less concerned with liquidity terms and more concerned with operational risk management. This contrasts with shorter-term investors such as high net worth individuals who tend to trade more frequently. These less sticky investors into hedge funds are more likely to continue direct investment into hedge funds while institutional investors are more concerned with the long-term benefits of the platform’s structure and governance.

 “Liquidity is certainly less important for institutional investors,” comments Stefan Roes, founder of AF Advisors. “It is not a goal within its own right and in fact pressure on a manager to maintain liquidity can really hurt performance. Liquidity definitely rates much lower than the actual risk and operational management and controls that a good platform can offer.”

Man Group’s solution
A good example of how this works in practice is the Man Group platform. It specifically seeks to emphasise the importance of accurate liquidity expectations over raising expectations of performance by making all the strategies liquid but then running the risk of having to tolerate a tracking error with the main hedge fund on which the managed account is based.

 “A key feature of the offering is that although common risk management controls and procedures are set, there are not as many restrictions when it comes to liquidity,” says Steve McGoohan, senior managed account analyst at Man Group.

 “We believe that the key lies in clear labelling and being truthful about what the actual liquidity is, rather than trying to apply uniform liquidity rules to very different accounts,” adds McGoohan.

Man does not apply gates or other restrictions but believes that the key to proper liquidity relies heavily on providing proper and manageable expectations. “That means being truthful and realistic,” he says.

In this context the real debate centres on accurate reporting. This ties in with demand within the wider asset management community for more frequent and granular reporting. It also reflects the demands of institutional investors who demand reporting that can be customised and tied into their systems to provide further value.

“Investors want transparency and detailed reporting and basically want insight from data as to things like performance attribution and risk reporting that can then be tweaked within their own systems,” points out AF Advisors’s Roes. He says the level of detail demanded depends on the investor. Investors into platforms as a rule have less expertise than those in commingled funds and are happier to let the platform’s own reporting systems do the risk analysis and general reporting work rather than tweaking data using their own systems in addition to the platform report.

Reporting quality is an issue. Most say platform operators need to have the right structures in place for operational and risk control and management.

“Hedge funds are complex legal structures that exist to provide the right structures to provide operational risk control and define its deliverables in terms of risk control and be able to report on that accurately,” says Hedgemark’s Phillips.

He thinks the demand for more frequent and detailed reporting requires platforms to be transparent across the whole investment process in order to be able to provide an aggregated view of risk in a timely fashion. “We are seeing unprecedented demand for position-level reporting from regulators and investors alike,” Phillips notes.

Looking forward
Moving into 2012 it is clear hedge fund managers are more willing to entertain managed accounts and are embracing platform structures while investors, looking for more solid risk controls as well as direct control over their investments which they believe cannot be expressed through a commingled fund, are also turning to platforms.

A robust platform structure adds considerable comfort on the risk front. It also gives a uniform and consistent approach that makes access to hedge funds through the platform inherently attractive to investors when compared with direct investment. This allows investors to diversify their investments into hedge fund strategies within a relatively secure environment.

Until recently some managers were reluctant to operate managed accounts, let alone be part of a platform. Some regarded the risk and compliance hoops as irksome and questioned the validity of an approach that might require them to adapt their strategy to provide more frequent liquidity.

“Funds want to know that it is worth their while to go down the platform route and that by doing so they get access to good-quality capital and investors. Being on the ‘wrong’ platform also incurs reputational risk for a manager – for example if their strategy is inherently unsuited a platform with high liquidity levels that they cannot hope to emulate without significantly changing the strategy,” comments Hedgemark’s Phillips.

With the tightening of investment flows, even the more established managers are actively seeking platforms. They have seen demand is sustainable. Cheyne Capital is one example of this. According to BNP Paribas’ Han, it has seen quality managers like Cheyne embrace managed accounts and added several to its own platform over the past few years.

“Hedge fund managers saw a big reason to change post-crisis,” adds Deutsche Bank X-markets’ Fothergill. “Many really suffered from having an investor base that was too concentrated and that they risked suffering from en masse redemptions. Clearly one of the key advantages of a platform is not only picking up the AUM but also picking up a more diverse investor base,” he says.

But choosing the right platform is still a dilemma for many managers as well as investors. For managers the most popular platforms are those that are flexible on liquidity and do not offer just daily or weekly liquidity. Managers also are keen to join platforms offering access to good-quality investors. Those with the biggest distribution reach and most robust operational infrastructures are able to offer economies of scale and hence a better fee structure.

For investors many of the same attributes apply. Platforms need to demonstrate sound corporate governance and operational risk management with sufficient infrastructure. The ability to produce comprehensive and useable risk reports for investors is seen as a solid selling point as well as the ability to aggregate data automatically.

But investors need to be aware that the platform model does not solve all the problems and is not a guarantee of performance by a fund or specific strategy. Care needs to be taken to make the right choice of platform provider, with the best fit for managers and investors alike, according to Frank Dargent, head of business development at Amundi Alternative Investments.

“Before choosing a platform the comfort levels need to be there as regards risk management and the operational set-up. The platform ideally needs to be part of a big general industry player; the investment part of that firm having holdings on the platform is generally a good sign of confidence. In general it is all about the philosophy upon which the platform is built and whether the platform holds the right blend and mix of colours,” says Dargent.

As the platform model becomes more popular the next question is whether the variety and diversity of platforms on offer will also increase. “Around 2008 there were lots of new platforms that had just been launched most of which have since disappeared. The big players with the reputation and the critical mass will continue to succeed as long as they are able to offer the same terms and conditions to internal and external investors and thus avoid any conflicts of interest,” comments Han at BNP Paribas.

Size in the platform world does matter in terms of critical mass as well as the ability to provide the technology and infrastructure needed to monitor and service managers on the platform as well as investors. Some platforms also look to their parent company (usually an investment bank) for additional support and the economies of scale and global reach that entails.

“Global reach and a broad business model mean that we are able to apply an economy of scale and this has a real effect on our pricing model, adding value at the investor end. We can always look to negotiate discounts and seek to drive costs down while maintaining cutting-edge operational and infrastructure excellence,” comments Man Group’s McGoohan.

He also expects competition for managers as well as additional assets under management to be concentrated in a limited number of significant players. “Because of the inherent protective nature of this model, investors and managers alike will always look to the large, more experienced houses that can provide better levels of comfort,” McGoohan says.

Deutsche Bank’s Fothergill agrees. He does not expect a proliferation of management account platform offerings even if investor and manager demand is on an upward trajectory. “The barrier to entry for new platforms is high and the infrastructure required to operate is formidable. This combined with the fact that platforms are offering stability means that investors and hedge fund manager alike are going to go for an established offering with proven track record,” he says.

Dedication to managed accounts

With the expansion of the platform model to large institutional clients has come a growth in private or dedicated managed account platforms created for a specific investor. This can range from one or two accounts to a much broader offering and is, according to Martin Fothergill, global head of managed accounts at Deutsche Bank X-markets, a result of large investors into hedge funds starting to request bespoke packages in line with the amount they have to invest. It also coincides with disenchantment with the fund of hedge funds model. Some of the biggest institutional investors are turning to in-house solutions rather than using FoHFs for their hedge fund ­investments.

To be able to have a customised solution, however, is a combination of asset firepower as well as in-house expertise and experience as well as commitment to a more hands-on approach to investment. “Five million dollars is not enough to wield that kind of influence but something in the region of $100 million clearly makes exercising power and choice this worthwhile,” says Fothergill.

Recent cases include Man’s two private accounts for pension fund administrators the Universities Superannuation Scheme (USS) and Bayerische Versorgungskammer (BVK), Germany’s largest public pension fund with more than €50 billion ($69.5 billion) in assets.

Man was awarded a managed account mandate for initially €1.2 billion ($1.7 billion) by BVK. Under the agreement, BVK will start allocating funds in 2011. BVK will gain access to Man’s managed account capabilities. Man has grown managed account assets to over $8.7 billion (at January 31, 2011) and will provide services with regards to operational due diligence, manager take-on and risk management oversight for BVK.

BVK will have sole discretion for manager selection and portfolio construction.

In a separate agreement Man was awarded a managed account mandate for up to $1 billion by USS, the UK’s second-largest private sector pension fund.

The arrangement will initially last a minimum of three years. USS will gain access to Man’s managed account platform. Man, with more than a decade’s experience in managed accounts, will provide advisory services with regards to operational due diligence, manager take-on and risk management oversight for USS. USS will have sole responsibility for manager selection and portfolio construction.

“We see this as a significant growth area in terms of assets under management. This area of the market will not be a volume-based proposition but more where a pension fund administrator’s assets have reached a level where it is able to command a structure suited specifically to its needs,” notes Steve McGoohan, senior managed account analyst at Man Group.

A private or structured account means an investor is using a platform as a way to customise its own investment choices.

“Private accounts are very popular and essentially the investor is using the platform as a service provider to get the board members, the legal structure, the tax structure and the operational and risk parameters,” comments Soobong Han, product manager for the managed platform at BNP Paribas.

“The client retains the asset allocation decisions – they have the assets and the sophistication to make their own decisions but do not want to take the whole thing in-house and bear the responsibility for it,” he adds.

“Private accounts are increasingly popular and part of the reason stems from the fact that with commingled accounts, there are a variety of investors all with different time horizons. This is to the disadvantage of pension funds that have longer time horizons, and can be impacted by investors like wealth managers who tend to take profits more immediately,” explains Han.

Geographical reach
The platform model is expanding geographically, too. “Big platforms have thus far tended to be European-based due to the way that the industry here has evolved and the historic leaning towards structured products that lend themselves so well to a platform structure,” notes Fothergill.

But he says his platform is currently looking at new areas in which to expand, especially in the US where he believes there is growing interest in the concept. Japan and other areas of Asia also hold promise, he believes, especially since many Asian investors find comfort in the operational and risk management structures a platform provides.

In Europe he expects to see further growth platforms offering the Ucits wrapper. “Ucits wrappers harmonise perfectly with the platform:  both are intended to provide security and harmonious investment opportunities.” Because certain classes of investors can only invest in hedge funds via a Ucits structure, he believes there will be a growing appetite for such vehicles in the future.
With the expansion of the platform model to large institutional clients has come a growth in private or dedicated managed account platforms created for a specific investor. This can range from one or two accounts to a much broader offering and is, according to Martin Fothergill, global head of managed accounts at Deutsche Bank X-markets, a result of large investors into hedge funds starting to request bespoke packages in line with the amount they have to invest. It also coincides with disenchantment with the fund of hedge funds model. Some of the biggest institutional investors are turning to in-house solutions rather than using FoHFs for their hedge fund investments.

Lyxor offers expertise

Managed account platforms are increasingly seen as a good option for in-house investment by some of the larger institutional investors, too. A good example of this is the decision by Dutch pension administrator PGGM to create a dedicated managed account platform for its hedge fund investments.

Like many other investors PGGM found the funds of hedge funds (FoHFs) through which it was making its hedge fund allocations had failed to deliver. Its re-evaluation of asset allocations started with some basic questions about how it invested and in what.

After an internal analysis, PGGM decided it needed to be in more control of its investments across the entire allocation, particularly so it could direct what was going on in terms of risk exposure. A strategic decision was made to continue hedge fund investment through a dedicated managed account platform.

To help PGGM implement its ideas, Peter Dom and Stephan Roes of AF Advisors were engaged as external consultants in early 2010. They assisted with the selection, product structure, set-up and implementation of the managed account platform for hedge funds investments. Dom was overall project manager and Roes was responsible for implementation.

PGGM eventually opted for a dedicated managed account platform where it would make investments, monitor risk and be able to have full transparency. The size of PGGM, its existing expertise as well as its intention eventually to allocate a total of around €5 billion ($7.1 billion) to managers through the platform, gave the organisation the confidence to pursue its plan.

Lyxor Asset Management has responsibility for operating the platform. This includes helping hedge funds selected by PGGM join (or leave) the platform. It supervises third-party service providers such as the administrator and trading counterparties while controlling net asset value (NAV) calculated by the administration. Lyxor is also providing operational, risk and tax due diligence, daily web-based customised risk and performance reporting and daily risk management.

Lyxor says it is now working on similar projects. The California State Teachers’ Retirement System (Calsters) has confirmed it is building its own managed account platform with the help of Lyxor.

Calsters, with a portfolio valued at $146.6 billion as of August 31, 2011, is the largest teacher pension fund and second-largest public pension fund in the US. At present no allocations are made to hedge funds but with the introduction of a dedicated managed account platform, Calsters intends to commit significant amounts to a variety of hedge fund strategies.

Other similar institutional investors in North America may also develop dedicated managed account platforms or other managed account solutions.

The model chosen by investors depends on the amount of money being invested as well as the specific needs of the institutions, according to Nathaniel Benzaken, head of managed account development at Lyxor which co-ordinated the project with PGGM.

AF Advisors agrees the PGGM model could be the one used in future by larger institutional investors. The company’s advice to those looking at creating a similar platform is to be precise and clear on what is needed and how the company wants to do it.

For investors who are unable or too small to create their own managed account solution, external platforms are increasingly seen as a good alternative to direct investment in commingled hedge funds. While more attractive to European-based institutional investors than their North American counterparts, it is clear that hedge fund managers on both sides of the Atlantic are keen to adapt strategies to the platforms.

Competition among the platforms is also increasing, giving investors more choice. This in itself brings additional problems, as investors need to understand the differences between the various platforms on offer. Fee structures may in future begin to play a bigger role in determining where investors put their money. Attracting a good selection of hedge fund strategies and managers will also be important in future.