Separately Managed Accounts: Can you deal with them? do you want to? How can you? Part I of II

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