Tag Archives: separately managed account

Increase Hedge Fund Transparency

Allowing Investor Viewing Access to Brokerage Account

I have recently been talking with many hedge fund service providers about what they are seeing in the industry right now. The following quote aptly summarizes what I have been hearing:

it’s a buyer’s market and managers need to be mindful if they are going to attract investors

Accordingly, this article will discuss one way of increasing the transparency of a hedge fund structure in order to appeal to potential investors who want some sort of confirmation that their assets are safe and are actually being traded.

Increased Calls for Transparency/ Separately Managed Accounts

Post Maddoff transparency has become the gold standard of the hedge fund industry. I have talked with various groups, both managers and service providers, who are seeing this need for transparency and there are a couple of ways we are working to address these issues for both the benefit of the manager as well as the investor.

As we discussed in an earlier post, separately managed accounts (SMAs) are a viable option for some managers who want to provide a managed account platform to investors. There are some drawbacks to the SMA platform but they do accomplish the goal of increased transparency for the investor and SMAs are becoming more popular. There are noted disadvantages to the structure (see SMA Advantages and Disadvantages) so I have been talking with various groups to try to figure out a good solution which keeps a fund structure but also provides transparency for the investor.

Investor Viewing Access to Brokerage Account

Many hedge fund administration firms provide daily net asset valuation services to investors. Typically these firms receive fund’s feeds from the brokerage account and are then able to translate that to each fund investor. Administrators then allow investors to access their own account information through an online account with the administrator. While such programs allow the investor to see how their investment is doing, the information is still second hand – it would be better if investors could see directly at the brokerage account level what the fund’s performance was like.

After discussing this issue with a couple of brokerage firms, I was happy to find that some brokerage firms can provide this sort of access to hedge fund investors. Basically the fund manager would request various administrative privileges or IDs which allow an investor certain access to the fund information. These privileges can be customized so that the manager can allow the investor to see as much or as little information regarding the fund and its trades. Of course these administrative privileges would not provide trading access to the investors and these programs will not generally segregate out an investor’s share of the fund’s assets like you would find with the administrators report.

When start up fund managers are discussing brokerage arrangements with various firms this is something that they should look into. Additionally, if a manager does decide to provide this sort of access to their investors the hedge fund offering documents should specifically describe the level of access being provided to the investor.

Please feel free to contact us about this article. We are interested in hearing your thoughts.

Hedge Fund SMA Interest Increases

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Separately Managed Account Program Becoming More Popular

It used to be, even just last year, that separately managed accounts were only offered in rare circumstances and only to a very select few investors. However, an increasing amount of managers are offering their hedge fund programs to investors through a separately managed account (SMA) platform. Market forces are pushing managers for more transparency and the managers are looking toward SMA programs more and more.

Background of the SMA

Basically a SMA structure is simply a managed account structure that many registered investment advisors used prior to the increased popularity of the hedge fund structure. In essence the manager has a power of attorney to trade the investor’s account. The investor retains many more rights in this structure and has more transparency into the underlying account, see hedge fund separately managed accounts.

As more and more frauds are discovered, transparency will become an even greater issue for investors. Due diligence should, likewise, increase.

Issues for the Manager

There are a couple of issues that the SMA platform presents to hedge fund managers. First, the manager will not be able to receive favorable tax treatment on its performance fee. One of the most desirable aspects of the hedge fund structure is that the manager can receive tax advantageous characterization on its performance fee (performance allocation) if the fund has underlying long term capital gains. With the SMA structure the performance fee will be taxed as ordinary income to the manager because there will be no “allocation” of the profits (because the SMA structure is not a partnership or taxed as a partnership).

The second issue that the manager should be aware of is that the SMA platform allows the investor insight into the manager’s proprietary trading program. Another central advantage of the hedge fund structure is that managers can keep their proprietary trading program secret. Investors in a fund generally will have no right to see the fund’s trades or inspect the fund’s assets. In a SMA the investor has complete transparency into the assets and the trades. While investors are seeking such increased transparency, the manager will need to weigh the marketing benefits of the platform against the potential downfalls.

Another issue is that the manager may potentially be subject to hedge fund registration if the amount of SMA clients exceeds either 5 (at the state level) or 15 (at the federal level). See also Issues with the SMA structure. A manager should discuss this issue with his hedge fund attorney.

Please contact us if you have a question or would like to start up a hedge fund.

Hedge Fund Separately Managed Accounts

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A common criticism or complaint about hedge funds is that they lack transparency. While many funds provide transparency to their investors through monthly or quarterly account statements, oftentimes these account statements do not detail the actual positions of the hedge fund. Because of this some investors who desire more transparency, generally large institutional investors and hedge fund of funds, will ask managers to manage money through a separately managed account structure (also known as a SMA structure or arrangement).

In the separately managed account structure the investor establishes a brokerage account and gives the hedge fund manager power of attorney over the trading account (also known as a “POA account”). Because the investor is the ultimate owner of the account the investor can see the exact positions in the account, although the manager will have the ability to trade the account. The POA can be as broad or as narrow as the parties agree and will be memorialized through two different documents: (i) a POA authorization with the brokerage firm and (ii) an investment advisory contract. The investment advisory contact will be drafted by the hedge fund lawyer and will include the business and legal terms which will govern the relationship.

The separately managed account structure is generally not common, however the need does arise from time to time when a side letter cannot address the concerns of an investor. For instance, some investors cannot invest in pooled investment vehicles which are not regulated under the Investment Company Act of 1940. A hedge fund manager who is not registered as an investment adviser will need to take care when entering into these arrangements as it will increase the number of clients that the manager has. Additionally, if a manager is registered as an investment advisor with the SEC or the state securities commission, the advisory contract may need to include certain state-specific items and the advisor’s Form ADV and Form ADV Part II will need to be amended within two weeks of entering the relationship.

Please feel free to contact us if you have any questions on the separately managed account structure.

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Tag Archives: separately managed account

Increase Hedge Fund Transparency

Hedge Fund SMA Interest Increases

Hedge Fund Separately Managed Accounts