Alternative Investment Management Association Representing alternative asset managers globally
Over the past four years, the global hedge fund industry has evolved to meet investors’ changing requirements through offering greater transparency and customisation. Hedge fund managers are now widely using managed accounts to deliver the flexibility that institutional investors and regulators now demand.
Illustrating the trend, in 2012 the proportion of assets invested in hedge funds via managed account platforms rose swiftly. A survey conducted by Hedge Funds Review put the growth in AUM at more than 15% in the 12 months to the end of June 2012.
But because managed accounts involve allocating investment activities across multiple entities as opposed to one comingled fund, operational costs tend to be higher, so the challenge is to build an efficient operational model to protect margins. Behind the scenes, administrators are investing significantly in technology to build the scale and flexibility to fully meet the evolving service models of managed accounts. As they do so, they are linking all the parties in the hedge fund value chain together and creating simplicity from complexity. This re-engineering of the industry’s technology foundations is preparing hedge fund strategies for their next stage of development and expansion.
Despite average relative returns and in the face of mediocre capital flows over the past two years, there is a sense that the industry has turned the corner in 2013, led by the institutionally driven changing investor demographics. Institutional investors seeking risk-adjusted returns have become the industry’s dominant stakeholders, and they are insisting on additional transparency and liquidity with the inevitable addition of cost to the industry.
The hedge fund industry’s ‘new normal’
In the immediate aftermath of the crisis, certain institutional investors such as pension funds started considering the use of managed accounts platforms to support their requirement for additional transparency into hedge fund strategies’ underlying assets. As time has passed, they have also sought greater customisation in the way that strategies are managed for them and, in some cases, lower fees. Increased regulation has also played a big part in managed accounts’ popularity with some managers using managed account platforms to create AIFMD-ready products in Europe.
While institutional investors’ tough terms of investment and tighter AIFMD and Dodd-Frank regulations are bringing challenges, they are also opening up the industry to a wider investor base. As the industry adapts to this new world, so it will improve its growth potential and managed accounts are well positioned to take advantage of this growth. As managed account platforms gain in popularity and sophistication, administrators’ advancements in technology are providing the flexibility for the whole hedge fund industry to adapt to the new reality, leaving hedge fund managers to concentrate on the task of generating alpha, without the distraction of in-house administrative functions.
Technology delivers scale and flexibility
Broadly speaking, three main managed account models have emerged:
In order to make these new-generation managed account platforms possible, administrators have rapidly built the technology they need to aggregate data at the platform level. They have connected the underlying investment managers, prime brokers, ISDA counterparties, middleware providers and clearing brokers. To do so efficiently, administrators have developed sophisticated technology infrastructures that include data warehouses, advanced transfer agency platforms and online reporting.
Administrators are backing technology with global infrastructures and specialist expertise. Some have offices in the three main time zones delivering “follow-the-sun” service models around the clock. Specialist risk and valuation capabilities cater for even the most complex strategies and exotic markets, on a daily or intra-day basis, in line with the liquidity profile of the managed account.
An ongoing trend
Managed account platform promoters are looking to leverage the administrator’s expertise and scale in such areas as collateral and treasury management, liquidity management, FX calculations and share-class hedging. As levels of transparency increase and new regulations come into force, the demands on administrators’ technology are intensifying significantly. Without doubt, the rigours of complying with new regulations are driving a continuous analysis of how the scope and bandwidth of ancillary services can be improved, and how data-capture and downstream reporting capabilities can evolve. Industry participants have to appreciate that this comes at a cost and this has to be taken into account when looking at managed account platforms as an option.
Looking to the future, the credit crisis’s implications for the hedge fund industry are becoming clear. It has resulted in the industry providing investors far more visibility into how their assets are managed and administered on a real-time basis. The cost of providing this information is pushing the sector to create scale through the administrators in a way it never had to before. Managed accounts will evidently become more and more popular in the next few years – and the administration sector’s growing investments in technology will make this possible.