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AIMA and KPMG on Managed Accounts

AIMA’s new managed accounts guide tells us that an investment manager considering the use of managed accounts should consider certain disadvantages that come with this product, and may want to negotiate around these difficulties with investors.

For smaller investment managers in particular, the increased regulatory and operational requirements can be a burden.  Costs are greater, both in the initial set up and in continuing operations.

Let’s review the basics.

A managed account is an investment account that is not commingled, and over which the investor retains ultimate control, though delegating day-to-day management to the manager. The delegation is accomplished by the Investment Management Agreement. The IMA will be customized, and may for example include “key man” clauses. The negotiations on the IMA also typically take in risk management guidelines, leverage, and the ability to increase or decrease funding of the account periodically.

Critically, an investor can amend or terminate the IMA without fearing the cloture of a gate, such as may block an analogous action in the hedge fund context.

Likewise, since no other investors are involved, the sole investor in a managed account need not worry about side pockets or side letters.  As AIMA puts it, one of the great benefits of such an account for an investor is “insulation from the types of impacts that investors in traditional commingled funds can have on each other when they subscribe or redeem in large amounts.”

Indeed, some institutional fund managers live within their own mandates not to invest in commingled accounts. In such a case, the availability of separate managed accounts, as AIMA says, creates “the ability to invest in certain alternative strategies” otherwise off limits.

Of course although liquidity is often listed as a benefit, a managed account is not likely to be as liquid as, say, a checking account. Liquidity will be constrained by the illiquidity of assets within the account, as acquired by the managers in their day to day trading and as permitted by the IMA. But liquidity is a much less complicated problem even then.

The Negatives

So it isn’t mysterious why there is a demand for the product. What difficulties might investment managers encounter in supplying that demand?

AIMA makes these points. The fact that the investor, rather than the manager, chooses counterparties and service providers can itself increase operational risk; the transparency and reporting rules, simply because they are different from the rules that apply to the same managers’ commingled funds, will be an administrative burden; an MFN agreement with other clients may force a manager to “provide any additional benefits negotiated with a managed account investor:” to those earlier MFN clients in a ratcheting effect; anti-money laundering and know your customer and similar rules and regulatory systems may add to the complexity of maintaining such accounts.

These negatives justify the large minimum investment thresholds that managers often impose on such accounts.

Remembering the KPMG Report

KPMG made many of the same points in a paper released thirteen months ago on “accessing hedge funds through managed accounts.”

From the point of view of hedge funds in particular, managed accounts are attractive, as KPMG observed, because they cater to investor demands for transparency, liquidity, and customization. They are “key to … evolution within the hedge fund industry” in all these respects.

KPMG raised the intriguing issue of the value of the commingling of the investor’s funds with the manager’s own funds. In a hedge fund proper, the managers are often “eating their own cooking,” and this is seen by some as valuable in its alignment of the interests of managers and investors. But in a managed account, by definition, that won’t happen.  So does that imply misalignment?

Not necessarily. KPMG suggested structuring fees for the maintenance of an account in favor of incentive fees, as mitigation.  Relatedly, it says that two thirds of the respondents to a survey say that they expect that specialization of account related fee structures “will be a key growth strategy to attract investors over the next 5 years.”

The bottom line, though, is that despite the costs and challenges, KPMG expected that managed accounts will continue to increase in popularity and would be a critical factor within the alternatives industry. Thirteen months onward, that bottom line seems to have held up.