“Simple can be harder than complex…” – Steve Jobs
As investors demand for the separately managed account structure (SMA) increases, hedge fund managers need to be operationally efficient to support this investment type.
A SMA is an investment account typically owned by a single investor which is ‘managed’ by an external party. The benefits to the investor include asset ownership, capital efficiency, liquidity and transparency. The main benefit to the manager is access to a pool of capital that would otherwise be closed to them in their primary fund structure.
The principles of a managed account appear relatively simple, an investor opens an account and the manager simply plugs in and arranges the trading for that account. But as with everything that appears simple, there is significant complexity in the ultimate execution.
Any hedge fund manager seeking to enter into this type of arrangement will need to consider how to implement three primary factors: 1) trade execution, 2) operations and 3) regulation.
The trade execution process will require connectivity to ensure transition of orders, but beyond that, there will be a requirement to manage and monitor the equitable treatment of the SMA and any other products operating the strategy. Furthermore, if the SMA is a ‘mirror’ of an existing fund it will require continuous monitoring to ensure the two products remain balanced, with further consideration when supporting any trade restrictions and subscriptions or redemptions.
The typical SMA is operationally more efficient than a traditional fund structure, though this is not always the case. As with any managed product, the manager is required to maintain books and records, and ensure they reconcile with the SMA’s own records. An important point to consider here is the ‘trading level’, which is the defined AUM risk that the SMA is actually allocating, as this will differ from the actual cash settled in to the SMA, which is there to cover the margin requirements only. In addition, the calculation of fees typically lies with the manager and/or an independent accountant, so the methodology for such must be clearly defined, especially where the trading levels can fluctuate intra month.
Finally, the regulatory requirements for the SMA are very much in line with the traditional fund structures. The AML and KYC are by no means absolved, and where a fund would delegate this to an administrator, for an SMA this lies with the manager. Beyond this, and its continuous monitoring, there is the conduct of business rules that need to be applied (depending on your regulatory jurisdiction).
With the above factors resolved and procedures implemented, the final challenge is volume. The whole ethos of SMA is that they are individual investors and by definition, if you are pursuing these assets, you will be managing multiple SMA’s. As a manager adds more SMA’s the trading, operational and regulatory workload increases with each addition. Efficiencies are limited, as the SMA’s may have a differing custodian, broker, fee structure etc., all of which will need to be individually implemented. Therefore, the operating efficiency of the traditional fund structure is lost.
SMA’s come at a cost, and operational efficiencies are paramount to ensure profitability. Through the implementation of technology, and years of experience, Quay Partners has developed an SMA operations solution which maximizes opportunity and minimizes risk.
To learn how Quay Partners can guide your business to success, contact us for more information.
Quay Partners Group delivers bespoke investment management solutions to independent hedge fund managers and family offices.
Thomas Underwood, the Founder, has over 20 years’ experience in managing and operating hedge funds.