With asset segregation, the hedge fund investor with a managed account benefits from increased transparency and greater control. With a managed account complete account details can be viewed versus top ten positions only for a typical commingled fund report. This though is a concern for some managers, who view their underlying positions as key intellectual property and want to limit replication.
There is control to invest or divest. The investor has trading authority for the account which limits the manager’s authority to move cash or securities and provides greater oversight vs the opaque structure of commingled funds. The investor can take control, if the hedge fund manager repeatedly breaches risk guidelines.
The increased transparency of a managed account gives the investor improved understanding of the liquidity of the hedge fund investments. With asset segregation, the investor is not impacted by other investors’ actions which can affect a commingled hedge fund investor’s ability to divest due to gates and side pockets. There is focus on the underlying investment. And managed accounts can still contain illiquid assets as per the Investment Managment Agreement (IMA).
The investor has the scope to set targets, guidelines and restrictions to meet specific circumstances. The commercial terms can be negotiated with the hedge fund manager. This ability to negotiate hedge fund fees is appealing to the cost conscious institutional investors as hedge fund fees are perceived to be high relative to other asset classes. Fee structures can be altered from the standard ‘two and twenty’ base and performance fee, to a flat fee only or a performance fee only. Lock-ins and fees based on performance over longer periods (e.g. rolling 3 years), as well as performance fee hurdles and claw backs, can be incorporated to further negotiate fee structures. This flexibility enables the management fee to be adapted to reflect the level of risk that the manager is being asked to take in the portfolio (fee per unit of risk) — for example if a managed account has a volatility target lower than the equivalent commingled fund, it would have a lower management fee.
Reports can viewed live with daily reporting vs weekly or monthly reporting which is typical for commingled funds. The investor can understand how the manager runs the portfolio, see where returns are being generated and be aware of periods of underperformance. From an operational perspective, risk is limited as the investor sets up the structure and appoints the third party.
The benefits of improved monitoring and risk management are not limited to the hedge fund investment. The underlying positions and exposures can be accurately aggregated with other assets held in the investors overall portfolio. Typically, in a commingled fund, positions must be estimated.