Hedge Funds Giving SMAs Warm Embrace
Investor demands for access, transparency spurring adoption
January 5, 2009
George Soros, in recent testimony before Congress, predicted that the global financial crisis will wipe out as much as three-fourths of hedge fund assets. Fearing massive losses, many fund managers have turned to separately managed accounts (SMAs) to appease investors.
"Currently, SMAs make up about 25 percent of our business, compared to about 10 percent in 2007. That number will probably double in 2009," said Michael Murray, partner at Shoreline Trading, a New York broker-dealer offering prime services to hedge funds and asset managers.
James Zurlo, head of prime brokerage sales at Chicago-based Gar Wood Securities, said his firm, which provides similar services, has told the managers it works with that it can support SMAs and "they should take a serious look at the accounts."
A traditional hedge fund account is opened by the manager and assets are purchased on behalf of the fund and pooled. Clients are limited partners and rely on the manager or fund administrator for performance information. That arrangement, combined with long lockup periods, has put considerable power in the hands of fund managers, who largely performed dismally in last year's volatile markets.
Investor concerns have intensified since Bernard Madoff's alleged Ponzi scheme came to light last month. Though Madoff wasn't a hedge fund manager, his investors were also given few details about investment strategy, trusting his acumen and account statements. Increasingly, investors struggling through the credit crisis are expected to demand easier access to their assets and more transparency--both features of SMAs. Since the assets are managed in the investors' accounts, individually negotiated agreements can address issues such as fees, objectives and the withdrawal of funds.
"Investors also get to approve all the cash flows--the money moving into and out of the account--providing another level of protection from managers buying into less liquid assets," noted Philip Stapleton, chairman of San Francisco-based broker-dealer Conifer Securities, which provides hedge funds with execution and middle- and back-office services including fund administration.
Tracking Capabilities
SMAs also let investors independently check on the status of their account through the custodian. "The investor can log in at any time and track the manager's performance," said Murray. "For investors, transparency has become critical, so they can also see trading activity and positions in their account. If they don't like the direction the account is headed, they can discuss that with the manager."
However, transparency can be a major disadvantage for fund managers, said Murray, since it is likely to prompt more frequent calls from investors, especially during volatile periods. Managers will have to establish expectations, he said--"You can't call me at 9:31 every morning," for example--and reach agreements to ensure clients are not replicating strategies in their own accounts at Charles Schwab. On the plus side, noted Murray, managers will no longer have to deal with audits or fund administrators.
A $100 million fund seeking to get to the next level could add SMAs on the side, observed Murray. "Managers are going to have to become more creative," he added.
Zurlo said late last month that Gar Wood was in the process of opening up two families of SMAs, one for a fund manager that was already a customer and another for a new client who six months ago "probably would have chosen to do one commingled fund." The existing customer is requiring a $10 million minimum investment, and the other $5 million.
