From evolution to flexibility; Darina Barrett, partner, Financial Services, Audit, KPMG examines hedge fund managed account platforms.
Hedge fund Managed Account Platforms (MAP) have origins in the investment banking world where they were created to support investment banks’ structured product offerings to institutional investors.
Certain events related to the global financial crisis (such as the failure of Lehman Brothers, illiquid markets and the fraud at Madoff), spurred growth in these legacy MAPs, as well as new entrants, due to the desire by institutional investors for liquidity and portfolio transparency.
The increasing desire by institutional investors to utilise MAPs for hedge fund portfolios, combined with the increasing number of hedge fund managers joining MAPs, has resulted in substantial growth for the industry.
As we move further away from the events of 2008 and 2009, and the focus of investors and the hedge fund community shift to the new challenges of today, the focus of MAPs has moved away from just liquidity and transparency to a much more diverse and expanded set of expectations, resulting in more diverse MAP offerings from market participants.
Flexibility is key in the industry today, and the options available to institutional investors, private banking clients and hedge fund managers are wide ranging and increasing as the months go by.
Many of the legacy platforms from the early 2000s (and prior), remain amongst the largest MAPs in the industry. These platforms have the advantage of long investment and operational track records, a reputation for operational excellence, and established relationships with many of the world’s leading hedge fund managers.
Combined with excellent distribution capabilities offered to hedge fund managers, economies of scale and related operating efficiencies, and comprehensive services including risk monitoring, risk management reporting and support, legacy bank affiliated MAPs have an established product offering popular with institutional investors and hedge fund managers alike. Since the global financial crisis, certain platforms have seen their growth stall as a result of the affiliation with large financial institutions.
Investors or fund managers have frowned upon conflicts of interest (whether perceived or real) resulting from the business structure (and/or tie-in to the structured products business of the sponsoring institution), legacy structures which may have become outdated in a rapidly changing regulatory and tax environment, or legacy information systems which lag in the support of the execution of the MAP as well as the client experience.
As a result, a new generation of MAPs is starting to emerge, offering innovations that are designed to serve the current needs and expectations of institutional investors and hedge fund managers alike.
The resulting MAP landscape is one of flexibility, fuelling a new round of growth of this global industry, and providing excellent options for investors and hedge fund managers to meet their needs in running managed accounts.
In the global financial crisis, liquidity and transparency were key drivers of MAP growth. Today, while liquidity and transparency are still very important, enhanced transparency specifically supporting an investors risk management function (and risk reporting needs) as well as independent governance, are key drivers of innovation in the new generation of MAPs at sponsors such as HedgeMark, InfraHedge, and Guggenheim Fund Solutions.
The investments being made in technology and support of investor’s risk management functions, are enabling investors to have a better grasp on the risks inherent in their hedge fund portfolios, and better information that is also enabling the overall growth of institutional investment in hedge funds.
These new entrants to the MAP landscape and the risk management support they offer are forcing legacy MAP providers to make investments in these capabilities as well, resulting in an overall better service by the industry as a whole.
In addition to risk management support, the concept of independent governance is also emerging as a important trend to institutional investors today, which is being met with solutions by the MAP industry.
Certain of the new generation, MAPs contemplate the involvement of independent directors and independent oversight of the MAP operations, and certain legacy MAP providers are responding with changes to their structures to include independent oversight.
Similarly, with the global investment management industry facing significant regulatory change (such as the EU’s Alternative Investments Fund Manager Directive (AIFMD) and the Dodd-Frank Act in the United States), new MAPs are being created using structures that are designed with these new regulations in mind (creating ‘AIFMD ready’ products for Europe, for example).
Legacy MAP providers who may be saddled with structures that were created well before the new regulations were drafted, are being forced to reconsider their structures (and in many instances create new structures or change legacy structures) to adapt to the new regulatory environment.
Rather than ‘one size fits all’ MAP structures of the past, many MAP sponsors now have multiple structures included in their MAP product suite, including UCITS wrappers, products structured in Ireland in contemplation of AIFMD, structures specifically intended for US distribution, and traditional off shore fund structures.
Furthermore, private banks are looking at the enhanced marketing of hedge funds available under the JOBS Act in the United States, as a means of educating and enticing private banking clients to access hedge funds through MAPs sponsored by these private banks.
The result of all of this innovation is a much more flexible product landscape to meet the diverse needs of investors, thereby providing more hedge fund access globally.
Plug and play
Finally, MAP providers also recognise that not all investors need the comprehensive set of services and products typically associated with legacy MAPs. As a result, the industry has evolved to include providers of platform operational solutions as a service, without the sophisticated risk management, monitoring, reporting, or other investment related capabilities tied to it.
Certain private banks, fund of funds, hedge funds and even institutional investors, find it convenient to locate a ‘plug and play’ platform provider to handle the structure, operations, administration, accounting and other day to day functions of running a platform, with a fee structure that contemplates only the mechanics in the operations of the platform without the value added (and more expensive) functions supporting risk management.
The resulting evolution of the MAP industry provides flexibility to meet the needs of investors and hedge fund managers alike.
With MAPs now in existence, which are agnostic to managers, investors or even distributors, it is easy to find a ‘plug and play’ solution to meet the business challenges of today.
There are many recent MAP trades in the marketplace, which exemplify the benefits of the flexibility offered across the MAP industry. For example, fund of funds managers are engaging MAPs to offer managed accounts where previously only commingled fund of funds were offered.
The funds of funds don’t necessarily need distribution capabilities, structured products or even risk management support from the MAP; rather, they need an efficient, effective solution for running managed accounts that will not burden the fund of fund’s organisation with operational activities (and costs) for which it was not originally built to accommodate.
In addition, a hedge fund manager with assets under management that is not significant enough to afford the creation of an internal infrastructure to support managed accounts can now engage a MAP (cost-effectively) to provide the operational capabilities necessary to run managed accounts, thereby allowing the hedge fund manager to raise capital from sources not previously available.
Finally, a large institutional investor with a diversified hedge fund portfolio that includes fund of funds investments and managed accounts may struggle with the operational infrastructure necessary to run such an investment portfolio.
This investor can now find efficient, comprehensive solutions for risk management, reporting, investment structures etc at MAPs, which more efficiently support a hedge fund investment portfolio.
Because of the significant investment in and innovation by providers of MAPs today, almost everyone interested in hedge fund managed accounts can find solutions to support their needs.
At KPMG, we are market leaders serving hedge fund managed account platforms, with audit, tax and business advisory clients ranging from several of the largest legacy platforms to many of the new generation platforms being launched today.
As a result of our market position, we are assisting clients with many novel ideas and witnessing innovation. It is from this vantage point that I believe the next five years will yield significant growth for the managed account platform industry, capitalising on new solutions to meet the needs of institutional investors, private bank clients and hedge fund managers alike.
*This article was originally published in Funds Review Ireland 2013.