Pensions & Investments reported earlier this week that private equity behemoth the Carlyle Group was expanding into the hedge fund managed accounts space. The newspaper quotes Carlyle’s Michael Arpey as saying that managed accounts represent “the next evolution of innovation” in the hedge fund industry.
Proponents point to managed accounts’ enhanced transparency. But as we’ve noted before, transparency is enjoyed only by the mega-investors that can afford to establish their own managed accounts. Smaller investors are stuck with traditional commingled funds offering traditional (read: limited) transparency.
But opponents of managed accounts – many of whom are hedge funds themselves – argue that providing a managed account allows investors to divine the positions in the pari passu commingled fund. Providing such transparency, the argument goes, opens the door to all sorts of anti-social behavior such as front-running on trades and free-riding on the manager’s hard work. Any manager worth his or her salt wouldn’t want to give away the secret sauce, right? (Even if that transparency was only granted to the managed account owners.)
But is this true? Is there a “cost” to providing transparency? Rajesh Aggarwal of the University of Minnesota and Philippe Jorion of the University of California, Irvine wondered if the performance of hedge funds with pari passu managed accounts was any different than that of hedge funds that did not offer such accounts. In a new paper, they use a fund’s willingness to provide managed accounts as a proxy for their willingness to provide transparency. (Some may find this to be a bit of a stretch, but work with us here.)
It turns out that the proclivity to offer managed accounts depends on the investment strategy. Managed futures funds tend to offer managed accounts willingly while long-short equity managers aren’t so keen. (Chart below created with data from Table 1.)
So is there a “cost” involved with offering managed accounts? Apparently not according to Aggarwal and Jorion. In fact, the performance of managed account providers is pretty much the same as that of those who don’t provide them. Notably, hedge funds that provide managed accounts did way better in 2008 than those who did not provide managed accounts. But overall, the cumulative outperformance of the managed account providers was found not to be statistically significant. (Chart created with data from Table 2.)
Who are these managed account providers? It turns out they’re smaller and younger than their managed account-shunning peers. This won’t come as a surprise to those who see managed accounts as a necessary evil to be endured only by newer funds who need the money.
Although the performance of managed account providers and non-providers was statistically similar, the return difference between managed account providers and non-managed account providers seemed to be related to the investment strategy used. For example, convertible arbitrage funds that provided managed accounts (and the transparency implied by them) seemed to dramatically outperform covert arb funds that did not use managed accounts. By contrast, global macro managers that provided managed accounts tended to under perform their more secretive brethren. (Chart below created with data from Table 3.)
Some wonder if a closed fund that is open to a managed account is an oxymoron. After all, is a fund truly closed to new investors (perhaps for “capacity reason”), then shouldn’t it also be closed to pari passu managed accounts? It turns out there may be some truth to this. Aggarwal and Jorion found that closed funds that offer managed accounts underperformed closed funds that were also closed to managed accounts. BUT, when they value-weighted the returns, the “no-managed-accounts” closed funds outperformed those that did provide them. (Chart below crated with data from Table 6.)
It seem that the bottom line is that the differences between the managed account providers (the “more transparent” group) and the non-providers (the “less transparent” group) is minimal and not very statistically significant. In other words, the “cost” to providing transparency in the form of pari passu managed accounts appears to be pretty insignificant. Sure, it’s not “public” transparency, but this form of “private” transparency doesn’t seem to leave managers any worse for wear.