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Structuring managed accounts to meet institutions’ needs

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Many small and, even medium-sized, institutional investors are uncomfortable with investing directly in single-strategy hedge funds, for a variety of reasons.

Many small and, even medium-sized, institutional investors are uncomfortable with investing directly in single-strategy hedge funds, for a variety of reasons. These include that they do not always have the investment and due diligence expertise in-house, and the cost of acquiring or developing that expertise would be uneconomic. In addition, their internal rules prevent them from making large allocations to any single fund. They typically prefer to rely on the expertise of funds of funds or multi-manager funds to enter the market.

Yet large amounts of money flowing to hedge fund allocators bring problems of their own. Up until recently, there was no structure that ticked all of the end-investor’s boxes. The classic fund of funds route avoids capacity constraints, offers diversification and outsources research, due diligence and fund selection. But the flipside is that funds of funds are expensive and also lack full liquidity and transparency.

Multistrategy funds have lower fees but suffer from limited liquidity and choice in the underlying managers and strategies. In addition, changing or liquidating a manager in a multistrategy fund can pose problems for the management of the firm, and significantly, there is also the potential for cross-collateral drawdown.

The managed account platform, which has grown in popularity, has its own advantages. There is full transparency in the underlying portfolios, daily liquidity for the manager, and flexibility in choosing and replacing managers. But fees are high, there is unlimited risk and there is also the potential of cross-collateral risk.

Custom House has developed a structure it believes is a step forward by comparison with existing offerings. It has designed a managed account platform that provides daily liquidity, transparency, flexibility and limited liability, and at the same time eliminates cross-collateral risk between portfolios.

In essence, the platform consists of a master fund with a series of managed accounts structured as segregated sub-funds that can be tailored to the particular investment demands of the fund manager’s clients.

According to Custom House chairman Dermot Butler, the driver for the concept was a client request. ‘Over two years ago, we were approached by a large Canadian bank that was running a multi-manager managed account programme in-house,’ he says. ‘They wanted to reorganise it and create a fund structure, both to create a marketable product and to get the platform off their balance sheet.’

Launched in December 2005, the master fund linked to 28 authorised segregated cells. ‘Each cell contained a specific managed account, organised as a sub-fund,’ Butler says. ‘They are ring-fenced by the segregated cell structure, so that no one sub-fund of the master can contaminate any other sub-fund, should it lose more money than it has in assets.’

With its network of offices in Dublin, Chicago and Singapore, Custom House is able to provide a daily tradeable NAV for investors in any region of the world. The Singapore office was originally set up in January this year with the intention of servicing the fast-expanding Asian hedge fund sector, but that original aim was soon superseded. Butler says: ‘Because of the demand for daily dealing, capacity in our office was quickly taken up.’

He says potential clients and competitors are sometimes surprised that such an offering exists. ‘It is very innovative. People ask us if we are providing indicative NAVs. We have to inform them they are tradeable.’

Custom House chairman Dermot Butler

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