Getting transparent exposure

Managed account platforms are fast gaining popularity among institutional investors looking to get exposure to the “good” risks of hedge funds investing.

The mere mention of “hedge funds” is probably enough to send a chill up the spine of many investors these days. Indeed, it is understandable why investing in hedge funds has become such a scary thought, given the negative publicity arising from scandals and the collapse of many hedge funds over the past year.

However, the truth remains that most hedge fund debacles have not been caused by bad investment decisions, but are a result of non-financial risks such as the risk of fraud, operational risks or counterparty risks.

This understanding has given rise to concerns among institutional investors about the lack of liquidity and transparency of traditional hedge funds.

This is why institutional investors are finding the idea of a risk-controlled platform that is able to reduce to a minimum such operational risks while controlling the financial ones, of hedge fund investing an increasingly viable solution.

Antoine Broquereau, Head of Structuring and Alternative Investment Solutions at Société Générale Corporate & Investment Banking, says, “Hedge funds are often referred to as ‘black boxes’ due to the lack of transparency. Using the managed account is a way to cope with this issue because you’re effectively handing over the operational risk management function to a third party who makes sure that settlements are correctly done, that the net asset value is computed correctly while maintaining independency from the manager as a source of pricing, that the position is reconciled between the auditor, manager, prime brokers and Lyxor Asset Management.

Unlike traditional hedge funds where sometimes you have to rely on the manager to perform these functions, the use of a managed account ensures that potential conflicts of interest are reduced. The transparency offered by the managed account tells you what the manager is doing, whether he is leveraged, whether he is using all the limits given to him, and whether he is changing the strategy. This is key for actively allocating into alternative investment strategies.”

Managed accounts are essentially hedge funds managed according to a mandate with defined investment guidelines and risk limits given by an independent manager, such as Lyxor Asset Management (a subsidiary of Société Générale), to the manager to replicate the strategy of the benchmark fund within the Lyxor fund. There is no link between the managed accounts and the original hedge funds apart from the fact that they are managed according to the same strategy by the same fund managers.

“Last year's fraud cases and other hedge fund scandals have resulted in a dire need for transparency and more thorough due diligence and monitoring of portfolios of clients investing in hedge funds and fund-of-hedge funds.

Clients want to know what the risks are in their portfolios and they want to be able to control these risks.

Many funds have changed their liquidity conditions since last year, and clients want to know that their investments are liquid and will remain so,” Broquereau adds.

Fraudulent activities, the dangers of which were highlighted by the Bernard Madoff case, have made it even more pertinent that investors are able to monitor their exposures closely, understand the strategy of the manager, and are able to get access to the fund manager on a regular basis. “In last year's fraud cases, there were many links between the manager, the prime broker and administrator of the fund. By breaking up such links through the use of a managed account, you make sure there is no conflict of interest between the different activities,” Broquereau says.

Another advantage of the Lyxor managed account platform is the weekly liquidity that it provides, Broquereau notes. “We have been committed since the very beginning to providing weekly liquidity, and Lyxor makes sure the underlying instruments are liquid enough so we can cope with flows on a weekly basis. Increase in the managed accounts AUM since the begining of the year is a clear sign of investors finding the right solution in Lyxor AM's set up,” he adds.