Managed accounts or SMAs (Separately Managed Accounts)have become a popular funding arrangement between certain investors and hedge fund managers. In this type of arrangement, these investors have their own individual accounts, separate from other investors, and the hedge fund manager has the responsibility of managing these accounts.
Typically, investors offering SMA funding are sophisticated with great monitoring and risk assessment infrastructures that enable them to oversee SMA arrangements.
While there are advantages to managed accounts, there are also disadvantages that investors and hedge fund managers need to consider before entering into such an arrangement.
Pros for Investors:
1.Greater Transparency: One of the main benefits of managed accounts is greater transparency. Investors own the account and have visibility into their individual account holdings, trades, and performance. This allows investors to better understand the risks and returns of their investment and make more informed decisions.
2.Customization: Managed accounts provide investors with greater flexibility and customization options. Investors can have their own specific investment objectives, restrictions, and preferences, including bespoke investment time horizons, which can be tailored to their individual account. Direct ownership of SMA assets provide more control over capital gains & losses and refining tax benefits.
3.Control: Managed accounts provide investors with greater control over their investment. The investments within the managed account are held in the name of the investor. They can monitor and adjust their investment strategy as needed and can even terminate the account if they are dissatisfied with the manager's performance, often according to agreed-upon performance criteria and drawdown terms.
4.Aligned interests: In instances where investor and manager co-fund an account there is assured common interest.
Pros for Hedge Fund Managers:
1.Increased Assets Under Management (AUM): Managed accounts can increase AUM for hedge fund managers. By managing individual accounts, managers expand their investor base, attracting new investors who may not have invested in the fund due to concerns over lack of transparency or control.
2.Establishing a Track Record: Emerging managers can use managed accounts to establish track records and credibility with institutional investors.
3.Reduced Redemption Risk: Managed accounts can help hedge fund managers reduce redemption risk. If an investor wants to redeem their investment, it only affects their individual account, rather than the entire fund. This can help mitigate liquidity issues for the manager.
4.Reduced Regulatory Burden: Managed accounts can also reduce the regulatory burden for hedge fund managers. Since each account is managed individually, managers do not have to file as a collective investment vehicle, which can reduce the regulatory reporting requirements.
Cons for Investors:
1.Incremental Cost of Monitoring: Investors need to have infrastructure, systems and staff in place to monitor and track investor performance.
2.Higher Fees: Managed accounts can have higher fees compared to investing in a hedge fund. Since each account is managed separately, the manager may charge a higher fee to compensate for the additional work required.
3.Limited Diversification: Managed accounts can also limit diversification. Since the account is managed separately, the investor may have limited access to the manager's full range of investments, which can limit the investor's ability to diversify their portfolio.
4.Risk of Manager Concentration: Managed accounts can also pose a risk of manager concentration. If the manager is managing multiple accounts, there is a risk that they may become overconcentrated in a particular stock or sector, which can increase risk for the investor.
Cons for Hedge Fund Managers:
1.Increased Operational Costs: Managed accounts can increase operational costs for hedge fund managers. Each account needs to be managed individually, which can increase the cost of back-office operations, reporting, and compliance. In FLC arrangements with emerging managers however, the provider typically offers an institutional quality operational infrastructure as part of the arrangement, benefitting both parties.
2.Increased Risk: Managed accounts can also increase risk for hedge fund managers. If one account performs poorly, it can damage the manager's reputation and make it more difficult to attract new investors.
3.Reduced Flexibility: Managed accounts can also reduce flexibility for hedge fund managers. Since each account is managed separately, managers may have less flexibility to move assets between accounts, which can limit their ability to make investment decisions.
In conclusion, managed accounts can provide both advantages and disadvantages for investors and hedge fund managers. Investors can benefit from greater transparency and customization, while hedge fund managers can increase AUM and reduce redemption risk. However, investors may face higher fees and limited diversification, while hedge fund managers may face increased operational costs and risk.
Ultimately, investors and hedge fund managers need to weigh the pros and cons before entering into a managed account arrangement to determine if it is the right fit for their investment needs.
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