Managed Accounts and the Blogosphere: Basis in Fact, Not in Bluster

While I seldom get irked by those who criticize my points of view, a particular post (you have to scroll down to find it, titled “Managed Accounts for Morons”) recently bothered me enough to warrant a comment. I have no problem with those who disagree me, except when two conditions are at play:

1. They’ve got the facts wrong; and/or



2. They’ve got a lousy attitude.

In their response to my post last week on managed accounts, they cut-and-pasted my entire text and added the following commentary:

Interesting hearing views from people who have never run a hedge fund and have
little idea how the industry works. I was extolling the virtues of managed
accounts last week and still feel they are a clever way to solve a lot of the
transparency and illiquidity problems that direct investments pose. The
regulators certainly think this is a step in the right direction and many of my
investors - large institutions - love them too. Most portfolio management
systems cope well with running segregated accounts and they are relatively easy
to maintain (than say 5 years ago).

Let’s look at a real life managed
account platform and see what sort of low grade and novice Hedge Fund managers
sell their wares:

Argent Financial Group (Bermuda) Ltd.
Metropolitan
Capital
Argonaut Capital Management
Mount Lucas Management Corp.

Arnhold and S.Bleichroeder Inc.
MRM (Cayman) Ltd.
Bay Harbour
Management LLC
Okumus Capital
Caspian Capital Mgt LLC
Para Advisors
Inc.
Concordia Advisors Prodigy
Capital Partners LLC
Contrarian
Capital Mgt LLC
Proprietary Capital Partners LLC
Drury Capital Inc.

Prospect Asset Management
FA Asset Mgt
RAB Capital Ltd.
FX
Concepts Inc.
Riverside Advisors LLC
GLC Ltd.
Rumson Capital

Goodwood Inc.
Sabre Fund Mgt Ltd.
Grantham, Mayo, Van Otterloo &
Co. LLC
Salus Capital Mgt Inc.
Green & Smith Investment Mgt LLC

Sinopia Asset Mgt
Hyman Beck & Co.
SPARX Overseas Ltd.

Integra Investment Management LP
Tactical Global Mgt
Kellner DiLeo
& Co.
Theorema Asset Mgt Ltd.
Kinetics Advisers LLC
Tiedemann
Investment Group
Lansdowne Partners LP
TQA Investors LLC
Martingale
Asset Mgt LP
Winton Capital Mgt

No novices or low grade managers
that I can see. Most of these managers are seasoned veterans and a few manage
over USD 10 billion in assets and are owned by some of the worlds largest
Investment Banks like HSBC, Lehmans and Morgan Stanley. Hopefully this will end
the discussion.

[source: FTSE Hedge
Constituents]

Ok. So now you’ve got the full content that has gotten me slightly irritated. So let me parse the text in order to speak to the errors of fact and opinion that has prompted this post.

Interesting hearing views from people who have never run a hedge fund and have
little idea how the industry works.

IA Fact: I ran a $6 billion NAV, $13 billion gross, 20 strategy global multi-strategy hedge fund platform. It was, in fact, a Registered Investment Advisor in the US, and registered with the FSA in the UK and the Hong Kong authorities as well. Check the filings. I ran both multi-billion dollar managed accounts and direct fund investments. I think I am due a little more credit and respect than the author has given me. Just a little.

I was extolling the virtues of managed
accounts last week and still feel they are a clever way to solve a lot of the
transparency and illiquidity problems that direct investments pose.

IA Opinion: The author is pissed off that I wrote a post that went directly against his views. If you’ve got issues you can raise them in an intelligent manner. That would substantially enhance the credibility of your arguments.

The
regulators certainly think this is a step in the right direction and many of my
investors - large institutions - love them too.

IA Opinion: I know regulators like them and many large institutional investors as well. It doesn’t mean that they are going to get them from the marquee funds, notwithstanding this list you provided. Most of the oldest, most successful hedge funds on the planet are not represented on the FTSE Hedge Constituents list - but I’ll get to this point later. I am not averse to managed accounts - in fact, many times I myself insisted upon them - but to deny their drawbacks both in terms of secrecy and access to the widest array of top talent is a fool’s game. Don’t confuse the beneficial features of an investment structure with how they are received by those subject to their terms.

Most portfolio management
systems cope well with running segregated accounts and they are relatively easy
to maintain (than say 5 years ago).

IA Opinion: This is a gross over-simplification of the issue. Are systems better today than they were five years ago? Of course. But it is also dependent upon the complexity of the book - a multi-strategy book that contains bonds with embedded derivatives, hundreds of CDS and OTC derivative positions, a smattering of illiquids of different stripes is a far cry from a managed futures, equity long/short or risk arbitrage strategy. So while I directionally agree that the structural barrier isn’t what is once was, it is still not turn-key for many of the largest, best performing but also most complex hedge funds.

Let’s look at a real life managed
account platform and see what sort of low grade and novice Hedge Fund managers
sell their wares [then the list of the FTSE Hedge Constituents]…No novices or low grade managers
that I can see. Most of these managers are seasoned veterans and a few manage
over USD 10 billion in assets and are owned by some of the worlds largest
Investment Banks like HSBC, Lehmans and Morgan Stanley. Hopefully this will end
the discussion.

IA Fact: Uh, no, this doesn’t begin to end the discussion. Let me offer a little background. Managed accounts have historically been far more prevalent in Europe than in the US. Massive investable hedge fund platforms like SocGen’s Lyxor have been designed around managed accounts, enabling investors to slice and dice their portfolios and to layer on derivatives and create all manner of structured products as they like. European retail investors have long taken to structured products, embedding both leverage and optionality seldom accepted in the US. Further, US tax laws have generally been unfavorable to structured note investors, creating a further barrier to investment. Therefore, the managed account as an investment vehicle has flourished in Europe to an extent far beyond that of the US.

So my antagonist holds up the FTSE Hedge program as the argument for why my position lacks substance. I mean, if all these great funds are willing to be part of the investable FTSE Hedge Fund Index then how is it that managed accounts represent a barrier to investing in the best hedge funds? Well let’s first consider some aspects of what being in the program means:

4.1.1 b) Each eligible hedge fund must have monthly reporting with a minimum of monthly liquidity and have independently audited financial statements. Ok, so you know what this means - that great special situations manager (of which there are many) - forget it. Do you think David Tepper or Eddie Lampert is giving monthly liqudity? IT SIMPLY WOULDN’T WORK WITH THEIR STRATEGY, as it wouldn’t for many who invest in this manner. So if you are ok with that, cool with me. But at least acknowledge that you are giving up a valuable slice of the hedge fund universe.

4.1.1 d) Each eligible hedge fund must be open and accepting subscriptions as well as having significant remaining investment capacity. Right. So all those big, elite, prestigious funds that are conspicuously not on this list? That’s because they’re closed. Existing investors who are long comfortable with the manager’s style, track record, risk management and reporting are the ones who get dibs on capacity when it becomes available. Are these funds accepting big institutions - even the Goldmans, Morgan Stanleys and Lehmans - who are demanding managed accounts? No way.

5.2.1 Each constituent hedge fund in the index is represented either by the constituent hedge fund itself or by a managed account that is benchmarked to that hedge fund. So, for purposes of clarification, a member of the FTSE Hedge program is NOT, by definition, offering a managed account. So let’s not jump to conclusions that every member on that list is, in fact, offering managed accounts. Monthly liquidity is one thing for a large cap long/short or risk arb manager - a managed account is another.

Just to be clear, my comments are not intended to speak ill of any of the funds that participate in the FTSE Hedge program. In fact, I know many of them and they are terrific. But they don’t begin to represent the elite of the hedge fund world or have the mass necessary to generalize that managed accounts are going to take over the hedge fund investment landscape. And I am happy to engage in spirited, respectful debate with anyone over these points. But don’t make egregious factual mis-statements that cheapen the debate. That is absolutely, positively not what the blogosphere is all about. At least to me.