By Paul Wick, Alternative Strategies Specialist
The 60/40 investment strategy that is rooted in Modern Portfolio Theory* maintains that diversification among asset classes will help boost returns. But, as investors have since migrated to a healthier mix of alternatives in their respective portfolios, this Theory should stress even more diversification. This migration to alternatives has led to an increase in the allocations being made to hedge funds. For example, through the third quarter of 2016, $21.1 billion** has been allocated to the Commodity Trading Adviser (CTA) space alone.
As the industry has shifted to include more alternatives in client portfolios, firms have looked to expand their in-house teams, which are focused on the research and sourcing of hedge funds. These teams are very adept at finding quality managers and appropriate strategies to meet the needs and philosophy of the firms. They also often search for service providers that can take on operational requirements when investing in alternatives. Historically, firms have utilized funds of hedge funds when that haven’t had the in-house capacity or resources to support this research. But, as teams have grown and focused more on their hedge fund investing they’ve looked for investments that provide greater control, lower fees, more transparency, liquidity, and governance, many firms have opted for doing the selection themselves.
To meet the specific needs of the investor, Managed Account Platforms (MAPs) provide a very attractive option for alternative investing. A MAP provides the investor with control over the manager selection and allows the trading manager to focus on what they are hired to do, and what they do best: trading. MAPs allow for the separation of operational and investment functions, thereby reducing and mitigating the risk of fraud and malfeasance, as the hedge fund manager only has trading authority, but not the ability to control the movement of cash and securities. Within a MAP, the manager is unable to impose any liquidity restrictions such as gates, lockups or suspensions.
Thus, MAPs have risen in popularity and have evolved into the operations partner for the investor. MAPs provide a solution that easily facilitates investments into hedge funds, while allowing firms to focus on the research and selection. MAPs also alleviate the burden of cost and operational requirements of structuring managers, aggregating data and monitoring manager activity. A MAP provides the investor with manager and counterparty due diligence, an easy to invest-in structure, transparency into the investor’s exposures, and guideline and risk monitoring. This provides investors with peace of mind that managers are executing the strategy as it was designed. Additional benefits may be passed on to the investor depending on the investment and platform structure, such as 60/40 tax treatment within managed futures, or the ability to add leverage to specific strategies. This should all be done in a way that exposes the investor only to the risk that is associated with the managers that they’re invested in.
Investors should view MAPs as a partner to their investing strategy, as a group that is hired by the investor that has their best interest in mind. MAPs provide investors with the tools, technology and resources to feel confident in their investing process while not feeling like they have to overwhelm their staff with new operations and procedures that accompany investing in hedge funds.
*This Theory was pioneered by Harry Markowitz in his paper “Portfolio Selection,” published in 1952 by the Journal of Finance.