As Bernie Madoff gets comfortable in his new surroundings, having traded his penthouse for the jailhouse, the issue of transparency has returned to the alternative investment industry with vigour and urgency. Perhaps no more obvious is this than in the very recent and profound resurrection of managed accounts in lieu of the typical hedge fund structure. Once relegated to the backwaters of the industry, managed accounts have returned as hedge fund investors demand, now more than ever, heightened control and disclosure with respect to their alternative investments. Given this renaissance, now would be an appropriate time to discuss the topic of managed accounts and understand its properties and characteristics.
The upheaval in the financial markets over the last few years has been varied but nonetheless stunning, with Bernie Madoff as just a single figure in this unbelievable period. Never before were the stalwarts of Wall Street so threatened with extinction, with firms like Bear Stearns and Wachovia playing the role of the dinosaurs in this ongoing evolutionary course. Compounding the issues further has been the complete meltdown in the global financial markets with almost all markets and exchanges suffering immensely. Each of these facets, whether it is fraud, bankruptcy or the ebbs and flows of the global economy, has highlighted key items for investors which to this point were given insufficient consideration previously. These include portfolio and institutional transparency, the impact of severe negative performance outside the usual market drops and counter-party risk. With these factors now on the tip of every investor’s tongue, a new paradigm shift has taken hold and managed accounts are stepping up to fill the perceived void in the alternative investment marketplace.
The Basics
Generally, a managed account is not all that dissimilar from a hedge fund. It is a segregated portfolio in which a fund manager is responsible for portfolio construction and security selection based on a given investment methodology. The fund manager is to undertake his or her investment strategy as per usual and manage the portfolio as in the traditional hedge fund structure. However, in managed accounts and unlike what is seen in hedge funds, an independent third-party (such as a custodian or fund administrator) has overall control of the account. That is, the fund manager chooses what to buy and sell and in what size, while the third-party handles other aspects of the portfolio and reporting, such as valuation, margining, and custody-related issues. Immediately, it is obvious why investors in this age of increasing risk awareness are flocking to a managed account platform.
