APAC: Managed Accounts and Conflicts—Part 2: Managed Accounts vs Commingled Funds
In our last post, we suggested that managed accounts of whatever structure have become more and more popular among institutional investors. Our list included advantages of managed accounts often seen in print or discussed among panel participants in seminars. We did not, however, itemize all of the incentives motivating many institutional investors to prefer managed accounts over commingled funds. We’ll do so now to introduce and illuminate the reasons why and how conflicts of interest are created when fund managers manage separate client accounts alongside commingled funds. And, hopefully, give you some takeaways when managing your own investment management business.
During the 2007–2008 Global Financial Crisis (GFC) and its aftermath, investors large and small became much more aware of the consequences of the actions of other investors in a commingled fund. This is known as “adjacency risk,” or the risk that some action that I take as an investor can harm your interests as an investor in the same fund. This risk arises not because I want to harm you; rather, the risk arises due to some structural artifact of the fund’s liquidity terms. In another, completely unrelated context, I have seen a similar phenomena described as polytemporal containment, nonviable timelines, and mitigating consensus risk, but what adjacency risk really refers to in the hedge fund context is the effect of gates and lockups, side pockets, and the like, on investor behavior (anticipated or otherwise).
During the GFC, investors were unhappy being locked into funds that were becoming ever more illiquid, while fund managers pursuing more liquid strategies were subject to the risk of ruin as AUM flowed from their funds as redemptions spiked. Shared unhappiness often leads to change, and this was no exception.
While liquidity mismatches may have been the primary motivating factor in the search for alternatives to investing in commingled funds, other investors looked more at the list of factors suggested in our prior post. That is, they looked to better align a manager’s strategy with institutional investor needs, such as avoiding some asset classes or ramping up or dialing down leverage in a portfolio. Still others were lead to favor what they believed would be enhanced risk management available in a managed account that would be difficult or costly for a manager to implement across a commingled fund.
The key difference between managed accounts—be it funds-of-one or separate accounts—and a commingled fund is the negotiation between manager and client of the investment contract or mandate. This nascent interest in managed accounts likely stems from incidents more than 15 years ago and is largely responsible for the prevalence of more customized, bespoke commingled funds today, but we’ll save that discussion for another day.
In our next post, we’ll tee up the major conflicts of interest facing managers who operate client accounts alongside commingled funds. The list is not short.
This series of posts will examine the particular challenges posed to managers when managing a managed account alongside a hedge fund, in particular, conflicts of interest that often arise when a manager is managing a client account that implements or overlaps with a material number of securities held by the hedge fund. Along the way, we’ll suggest best practices to manage these conflicts. More to come, watch for our next post.
View Part 1 Here: APAC: Managed Accounts and Conflicts – An Overview
View Part III APAC: Managed Accounts and Conflicts—Part 3: Separate Managed Accounts vs Funds of One