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| Managed Account Platforms |
In a managed account strategy, the hedge fund manager acts on the basis of a trading advisor agreement. This strategy is replicated on an account bearing the investor’s name. Managed accounts stem from investors’ need to minimize the operational risk and the disadvantages of investing in hedge funds, such as illiquidity, a lack of regulation, and a lack of transparency.
According to an empirical study of 100 hedge fund blowups by Kundro and Fefer (2004), 50% were triggered by operational risks such as fraud, data input mistakes, system crashes, and valuation problems. Managed accounts provide transaction and position transparency to investors via an electronic connection to the prime broker.
This enables hedge fund managers to control asset management constraints such as maximum leverage, asset classes, investable regions, and no illiquid assets. According to Jaeger (2003), the managed account investor may also inl uence all the involved parties (e.g., prime broker, custodian, auditor) and the legal agreements (e.g., prime brokerage agreement, ISDA swap agreement).
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By using managed accounts, investors can react quickly to hedge fund manager violations. they can thus close positions immediately (provided there is suficient market liquidity), which greatly increases investment liquidity. Portfolio transparency enables independent position valuation by the custodian.
It is also the basis for effective and active risk management. When investing in fund structures, position valuation is done primarily by the hedge fund’s prime broker. Furthermore, when handling illiquid positions, it is possible that only the last available market price is placed in the books, or that the valuation of such positions is performed by the hedge fund manager himself using his models.
The constant information flow and permanent account accessibility on managed account platforms are attractive for issuers of structured products with an underlying hedge fund asset. these properties provide optimal hedging and more precise risk control for products that have capital guarantee options.
Indeed, providers of investable hedge fund indices (e.g., ARIX, FTSE, MSCI, Dow Jones) prefer managed account platforms because of their higher liquidity and better transparency when selecting index constituents. However, the challenges of setting up a managed account, such as sufi cient transaction volume and the large required resources, should not be underestimated.
If, for example, a statistical arbitrage fund is to be replicated on a managed account, there may be thousands of transactions every day, which implies a large increase in administrative workload. The valuation methods are developed by the managed account operator, and the valuation interval is daily.
This can cause difficulty and increased effort on the part of the manager if he does not trade liquid instruments and even OTC contracts on a daily basis. Without a valid valuation, the significance of portfolio transparency and short valuation intervals is questionable.
Regarding the necessary resources, investors often underestimate the requirements for administering position information for a hedge fund portfolio. A sophisticated risk management system generally costs U.S. $100,000, not including implementation and maintenance costs. Hence, the minimum investment volume for setting up a managed account is between U.S. $5 million and $50 million.
The managed account concept exists in various forms and variations, and is classified according to Giraud (2005) as follows:
- Standard Custodial Arrangements. The assets are held in a specific account managed by the hedge fund manager.
- Prime Brokerage Custody. The assets are held in the name of the fund in a specific account managed by the hedge fund manager. The prime broker may serve as an independent risk control and valuation entity.
- Basic Managed Accounts. The assets are held in the name of the investor on the books of the custodian. The manager has the right to manage this account based on the asset management agreement. The bank serves only as an independent valuation entity.
- Managed Account Platforms (MAP). The assets are held in the name of the investor in separated accounts. the bank or the platform operator is in charge of the back ofi ce, valuation, and risk control duties. The platform itself can engage in prime brokerage contracts.
