EXCLUSIVE: Managed accounts seen to add alpha

Separate accounts generate alpha over and above co-mingled hedge fund investments at an annualised rate of 7.9%, according to a study by fund of fund manager Investcorp and the insurance company Allstate.

The findings challenge the popular conception that separate accounts are dilutive to the overall performance of institutional investment portfolios due to the high operational costs and perceived adverse selection bias associated with this approach.

Investcorp's chief investment officer Deepak Gurnani and Christopher Vogt, portfolio manager responsible for hedge funds at Allstate Investments, argued that separate accounts enable investors to manage risk more effectively and provide valuable insurance against losses, resulting in improved overall performance.

This is particularly the case during periods of market stress. Separate accounts outperformed investments in co-mingled funds by 12.4% in 2007 and 9.4% in 2008, according to the study.

The findings are based on an analysis of four large multi-manager portfolios overseen by Investcorp and Allstate. The portfolios contained between 48 and 98 distinct funds or accounts, with the number of separate accounts ranging from five to 42. The data covered the period from May 2006 to December 2009.

Gurnani and Vogt found separate accounts contributed 66 basis points a month in additional returns over co-mingled funds on average. While the incremental returns from separate accounts were highest during periods of market stress, the additional alpha remained positive even when markets were stable.

Given the extraordinary events of 2007 and 2008, Gurnani and Vogt concede the long-term average alpha contribution of separate accounts is likely to be lower than the 7.9% estimate based on the research sample. However, they found no reason to believe the alpha contribution of separate accounts is negative, even taking into account the additional operational costs associated with this approach.

Gurnani and Vogt concluded that for institutional investors who invest in hedge funds it is best practice to use separately managed accounts. They highlight asset protection, risk management and transparency as the main benefits. This helps investors to generate incremental alpha.

They predicted the use of separate accounts would continue to grow and said hedge funds offering separate accounts would enjoy a competitive advantage in attracting institutional assets.