Once expectations have been set and a good TMA is in place the next step is to begin working with a (hopefully your) prime broker to get the account up and running. In this Part II of the blog we will talk about the nuts and bolts of opening an account including executing on the TMA to working with prime brokers and allocating bulk trades via your executing brokers.

If your fund is not a new launch you may have forgotten all the things you had to put in place to fulfill the operational requirements of the fund. Hopefully you kept good notes because you now have to do it all over again for the new managed account including replicating ISDA’s, broker agreements, FX arrangements, client specific ID’s if needed in foreign jurisdictions, etc, etc. If the managed account is on the small size you may also run into the prime broker’s reluctance to open ISDA’s and other arrangements on the same terms as your core fund.

One of the key compliance issues is your policy on trading practices and potentially using bulk trades with allocations to each fund/account. When dealing with bulk trades and allocations there needs to be a policy in place to insure that neither the managed account nor the fund is receiving preferential treatment on trades. What will be your policy regarding bring the account back into balance with your core fund if you have agreed to run the managed account pari passu? Mid-month liquidity can wreck havoc on your trader depending on your and your client’s expectations. Additionally, if the prime broker of the managed account is not the same as your core fund you now have the challenge of (hopefully seamlessly) allocating trades. Depending on your investment and trading style you may be able to get away with using a simple trading system however if you use multiple executing brokers and deal with securities globally you may need to look at additional in-house capabilities such as OASYS.

Daily reconciling of the account for cash and positions also remains your responsibility. You’ll probably have a new administrator to work with so be prepared to deal with their unfamiliarity with your account and practices. You’ll typically be expected to either prepare the invoice yourself for management and incentive fees or at least be able to verify that the numbers your client provides are accurate. If you are not setup with an internal portfolio and partnership accounting package then now may be a good time to consider one. Software in the sub-$20k range is now available to handle these requirements. Remember the administrator on the managed account is not your vendor and you therefore have much less control and flexibility over them than the one you use for your fund.

In summary, while having a managed account is an added layer of complexity to your firm but if you are prepared it can be great asset and if you do a good job can it set you apart from your peer firms.

Duncan Huyler, CFO, 360 Global Capital

Post-Madoff and post-Lehman one of the more significant predictions in the hedge fund space was the potential for a huge increase in the number of separately managed accounts (SMAs). Increased transparency and the demands for liquidity after the meltdown the industry experienced in the recent past brought SMA advocates out of the wood work. The reality is that the "trend" may have been overblown or at least overhyped, however, for those funds willing to embrace the trend there is a differentiator that is potentially valuable and even lucrative.

Working with an allocator that has previous experience with SMAs can be a relatively simple process if you have your back-office operations in order. Ideally the Trading Management Agreement (TMA)—the contract that defines the role of the trading manager and the advisor-- calls for the portfolio to be traded pari passu to your core(target) fund. Any variation between the investment policies in the OM of the target fund and that of the SMA should be clearly spelled out in the TMA. Legal counsel should be enlisted to insure protection of the investment advisor in regards to indemnification- not just who is indemnified, but for what and by whom. The role of soft dollar accounts, expenses that can be charged to the SMA, the charge-back for admin, legal & audit fees as well as when & how the management fee and incentive fee are payable should also be detailed in the TMA. Confidentiality clauses need to be agreed upon as do expectations on reporting requirements.

Performance between the SMA and the core fund should be essentially identical however, differences can occur especially with significant cash flows. A policy should be in place so that when cash flows occur trades are placed to bring the account back into balance with the target fund. The trading manager should be prepared to reconcile any variances in performance to the satisfaction of the account owner.

If expectations have been set and a good TMA has been reviewed and is in place the next step is to begin working with a (hopefully your) prime broker to get the account up and running.

In Part II of this blog we will talk about the nuts and bolts of opening an account including executing on the TMA to working with prime brokers and allocating bulk trades via your executing brokers.

Duncan Huyler, CFO, 360 Global Capital, LLC