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James Williams, Hedgeweek

MAPs offer springboard for emerging managers


Managed account platforms allow institutions to broaden out their hedge fund allocations and invest in emerging managers with confidence, thanks to the strong operational controls they provide. At a time when some of the larger established names have suffered performance issues, diversifying into a wider mix of unknown managers is becoming of strategic import to institutions.

Speaking recently at a New York Hedge Fund Roundtable event, Robert Akeson, COO of Daewoo Securities (and the event moderator) was quoted as saying that small and emerging hedge fund managers, as a group, consistently outperform other managers. “However, as the physicists like to remind us from time to time, there are no free lunches; these managers are also known for their operational risk and many studies reflect that when these funds fail or disappoint it has a lot to do with operational risk,” said Akeson. 

This is a challenge that institutional investors must face as they increasingly turn towards emerging managers to add a bit of zest to their hedge fund portfolios. 

But there is a solution: the managed account platform. A tried and tested method, long used in the traditional fund space, for institutions to control the assets in managers they invest with, and at the same time benefit from enhanced operational transparency and liquidity terms. 

Heinrich Merz is CIO of Amundi’s alternative investment unit. Amundi operates one of Europe’s leading MAPs with approximately USD5 billion in assets. He says that the ability of segregated managed accounts (SMAs) to manage the increased operational or due diligence risk of smaller and emerging managers is one of their key benefits. 

“On balance, however, we emphasise the advantage of customisation to either enhance the alpha (e.g. focus on a manager’s key alpha generating strategies) or control risk (e.g. exclude strategies) that we perceive to have greater embedded tail risk of somewhat more established managers (i.e. not `day one’),” says Merz.

There are a number of different reasons for why investors wish to allocate to emerging managers. They might be looking for more performance from emerging managers because they are less constrained by overcrowded trades in the markets, or simply wish to gain exposure to more interesting, niche strategies that few others are looking at. 

Also, if large institutions concentrate too many of their assets among the same universe of say the top 100 largest hedge fund managers, and returns aren’t great, it adds to the pressure of why they invest in alternatives and fuels some of the negative perceptions that exist with these vehicles. 

Finding managers that might be young (in terms of track record) and small in AUM terms can give institutions a chance to really diversify away from their peers.

“It’s a learning curve for investors. It’s a change from what they’ve usually done so it takes time. In the beginning, clients who use our DMA solution tend to focus on trying to convert established managers. Now there’s a much greater focus to go beyond merely looking at large fund managers and consider smaller, talented managers,” comments Andrew Lapkin, CEO of HedgeMark, a BNY Mellon company. 

“Using a managed account platform to access emerging managers is, generally speaking, not difficult because these are managers who are actively looking to grow their asset base. It gives the investor more comfort to allocate to them using the managed account structure for many reasons: managing risk exposures, style drift, liquidity, leverage and so on,” adds Peter Sanchez, CEO of Northern Trust Hedge Fund Services.

Joshua Kestler is President and COO of HedgeMark. In his view, investors have become preoccupied with certain brand names of funds. “When you look at the hedge fund portfolios of most large asset owners you see the same names over and over again,” observes Kestler. “It is somewhat understandable as there is comfort in choosing the largest funds because it reduces reputational risk than if they invest with a smaller or lesser known manager. However, if most pension plans are invested in the same brand name managers and those managers perform poorly in a given year it brings down the image of hedge funds in general.”

Studies have shown that early stage managers tend to outperform later stage managers who have a lot of capital and find it hard to generate alpha as a result; they become asset gatherers. 

As such, there can be benefits to branching out beyond the most popular hedge fund names in the industry and as Kestler is quick to state: “I do think dedicated managed accounts can give investors the comfort to do so. They don’t have to worry as much about the manager’s operational infrastructure and can take a chance on a smaller manager with strong investment acumen or pedigree. We’ve definitely seen some clients take this approach and have success with it, and their portfolios are performing well this year.”

 Amundi’s Merz thinks that a significant degree of large manager underperformance over the last few years can be traced back to position crowding. He says that the position transparency that SMAs provide “allow our portfolio managers to manage crowding across portfolios more accurately”.

One could argue that irrespective of the size of the manager there will always be some degree of enterprise operational risk. Such is the depth and variety of hedge fund managers that a five-person quantitative fund could well have a more advanced IT infrastructure than a 50-person equity long/short fund. What a MAP allows the investor to do, says David Young, President of Gemini Alternative Funds, LLC (`Gemini Alt’), is remove operational risk concerns from their overall risk analysis of a manager. 

“They can analyse managers based purely on the investment thesis and how they employ that thesis to generate returns. That is a huge plus, not just for young emerging managers, but small established managers. I’ve seen situations where pension plans won’t talk to anyone with less than USD500 million in AUM; there are an awful lot of high quality fund managers operating below that threshold,” comments Young. 

Gemini Alternative Funds, LLC (Gemini Alt) operates an open architecture environment that facilitates the creation of dedicated managed accounts (DMA) for large institutions. The infrastructure is supported by Gemini Alt’s parent company, NorthStar Financial Services Group LLC (NorthStar), which has more than USD455 billion in AUM.

As well as the DMA platform, Gemini Alt also operates the Galaxy Plus platform, a CFTC and NFA regulated platform that provides a lower investment option to non-pension fund investors. 

Young confirms that they are now currently in the process of launching a second platform, the Galaxy Plus Hedge platform, a MAP that will give investors access to a variety of hedge fund strategies to complement its CTA-focused Galaxy Plus platform. 

“We already have four managers with investor seeding in place we are just working through all the legal documents. The aim is to broaden the scope of our offering. We have a strong Managed Futures platform and we want to achieve more balanced diversification for our investors,” adds Young.

The DMA platform covers any underlying trading strategy on either of the Galaxy platforms. Young confirms that Gemini Alt are currently working with a prominent US endowment that specifically wants to allocate to emerging managers. 

“One of the concerns they have is the infrastructure that these managers have in place. They believe that the manager can generate alpha but they want to make sure there is a standardised infrastructure that they feel comfortable with. 

“Over the next year, this endowment is looking to launch 10 emerging managers through us on the DMA platform. They can have the manager focus exclusively on the trading strategy and use the platform to provide the operational infrastructure and control. They are choosing the single strand that they like most about the manager – the strategy – and using the platform to build everything else around that strategy,” says Young.

Given that there are 8,000 or more hedge funds to choose from, a high proportion of which are smaller and emerging managers, getting manager selection right when looking to build a dedicated managed account portfolio is crucial. 

Daniele Spada is Head of Lyxor MAP. He says that being able to support its clients at the pre-allocation stage is one of the key features that differentiate the Lyxor MAP from other platforms. 

“This is particularly important in the context of the market environment we see today. With hedge funds suffering this year, including some large names, it is important to be able to select managers, including, in this context, emerging managers.

“We are an asset manager and we actively select managers. Our approach, and ability to do research and due diligence, is crucial. It’s what institutional investors are missing and really need. Our business model is not a supermarket, distribution-type business model,” explains Spada. 

Since the financial crash, there has been a polarisation in the marketplace. Investors have been looking for the same characteristics in a fund and the result is that assets have flowed to the top decile of fund managers. Spada agrees that investors should avoid to invest in the usual big names and “be a bit more open-minded and look for smaller and mid-sized managers – there is a lot of talent and different ways of running similar strategies in this part of the market.” 

The same is true in the UCITS world. The concentration of assets in bulge bracket managers is very high. Most investors have invested in big names and funds that offer a lower range of volatility. 

When it comes to taking a bit more risk and investing in less mainstream funds with higher volatility profiles, Spada says “there are not many investors that do this. We work to build portfolios of managers with our clients and we usually suggest allocations mixing large established managers in the core of the portfolio with a satellite of mid-sized emerging managers.”

The types of strategies that Lyxor has been looking at this year to source new managers, established or emerging, include: market neutral and variable bias long/short equity strategies; global macro, despite performance being a bit off this year; and event driven strategies. “They suffered last year but some are performing very well this year, at least on our platform,” says Spada.

Amundi too helps to source lesser-known outperforming managers for its clients. “However, we also believe that `day one’ investment carries significant operational risk: it takes time for a new investment team to bed down. As a result, we continue to maintain a high threshold for early stage / emerging manager investments whether through SMAs or otherwise,” clarifies Merz. 

He says that the emphasis at Amundi is on making the selection itself. “Nevertheless, in addition to other channels, we use our network of clients to source managers and have taken on portfolios of managers from clients.”

Platforms such as those operated by HedgeMark and Gemini Alt are slightly different in that they do not advise on manager selection. They provide the infrastructure solution that allows investors to invest safely and securely in managers that they themselves have a preference for. 

“For hedge funds that join Galaxy Plus Hedge we will do background checks, analyse the investment thesis and make sure we have a strong understanding of how the alpha is generated and whether it is unique. Everything we are launching at the moment is investor-driven,” states Young.

Large institutions might use Gemini Alt’s DMA platform and onboard a series of pre-selected managers, following which smaller institutional clients have a chance to allocate to on one of the commingled Galaxy platforms. “Galaxy Plus and Galaxy Plus Hedge give them close to the same attributes that our larger institutions are able to enjoy. Is the liquidity daily? No, it’s weekly. Is the transparency provided at the position level? No, it’s provided at the exposure level. 

“But it’s still a better investing experience for investors than investing in the manager’s offshore flagship fund.”

Much is made of the investor experience when talking about using MAPs but what about the managers themselves? Such are the costs of setting up a hedge fund today that many emerging talents need an alternative solution. Whereas the MAP is an effective investor solution, it is equally an effective route to market for new managers who do not want the burden of running their own fund. 

One such MAP is London-based Linear Investments, which provides a complete one-stop shop solution for those looking to trade their strategies and build meaningful track records; and in effect, catch the attention of investors for the reasons stated in this article. 

“We work with a number of family offices and other investors who like early stage managers,” comments Jerry Lees, Chairman of Linear Investments. “Generally it doesn’t make sense to start properly marketing a fund until they’ve built a solid track record. As a rule of thumb, they have to have a full three-year track record. Investors don’t believe in back-tested performance, the real world doesn’t have the benefit of hindsight.

“When a new manager joins our platform we do not charge for a managed account, other than the normal brokerage/execution or financing of the positions. We turn over very large volumes in all sectors: fixed income, equities, futures and options. As a result we can offer some of the most competitive commission and financing rates in the market.

“Also, as part of the managed account platform, because we run all the middle- and back-office processes we can give managers full reporting capabilities. This means they don’t need to use an external auditor or an administrator, Linear can supply the track record, or provide the data to an external auditor.”

Linear helps managers on the marketing side using a suite of software packages that can analyse the performance of the fund, produce all the necessary outputs that an investor needs such max drawdowns, Sharpe ratio, beta, correlation and so on. Moreover, if the manager wants to raise capital Linear will summarise the fund’s statistics in a one-page report for distribution to appropriate seed investors.

“These documents sit within the capital introduction section of our website. We have around 20 factsheets on individual funds at the moment. It shows track records, fund performance, etc. We also distribute these out to family offices and contacts that we have, and that we know are interested in those specific strategies,” says Lees.

Such platforms are playing a vital role in bringing through the next wave of talent. Some will go on to run large successful hedge funds, others will fade away. But the fact that they have an incubation model available to give them a chance to succeed, and to hopefully attract institutional investor capital, is not to be underestimated. 

“I would estimate that 20 or 30 Appointed Representatives on our platform have gone on to run their own hedge funds over the last few years,” says Lees, adding that he expects to have all 135 desks filled in Linear’s offices by the middle of January 2017. 

Each desk has four screens, full IT, all phone calls recorded, seven-year archives of all their emails; everything is done to a regulatory standard. They even get free coffee and biscuits in the meeting rooms.

That’s just the kind of sweetener that investors and managers come to appreciate with Managed Account Platforms. 

In conclusion, HedgeMark’s Lapkin says: “If investors are going to maintain their hedge fund allocations going forward they are going to have to look beyond the names that everybody has invested in for the last decade.

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