From lockups to gates to debilitating Ponzi schemes, hedge fund investors have endured more than their fair share of setbacks triggered by the global financial crisis. Now, in an effort to preserve access to their capital and minimize the risk of outright fraud, a growing number of fund-of-funds managers are allocating to underlying hedge funds via individual managed accounts that remain firmly under their control.
Lighthouse Partners, a Palm Beach Gardens, Florida–based fund-of-funds manager that oversees $5 billion in assets, launched its first fund of managed accounts in 2006, and today it runs four separate FoMA products. The firm expects FoMAs to account for as much as 80 percent of its business by the end of next year, up from about 40 percent today, fueled by interest from new investors as well as existing clients that are moving assets from the firm’s traditional funds.
“Our destiny is in our own control,” says Kelly Perkins, the firm’s co–chief investment officer, summing up the appeal. “The investment adviser has limited authority to do anything but trade the account. Their ability to invoke a gate is removed.”
Simon Hopkins, founder and chief executive of London-based Fortune Asset Management, an investment firm that caters to many of Europe’s wealthiest families, is also an advocate of FoMAs. “It will take time for the industry to transition, but all the sensible people recognize that this is an important part of the way ahead,” he says. In 2006, Fortune converted all of its traditional funds of hedge funds into FoMAs — including its flagship low-volatility offering. Today, FoMAs account for 10 percent of the firm’s $4 billion in assets, with most of the remainder invested directly with alternative managers.
How far FoMA managers will go in exercising control over their underlying hedge funds remains to be seen. John Pagli, who runs investor relations at Stamford, Connecticut–based WR Capital, which invests all of its $1.5 billion in assets using FoMAs, says that customization at the portfolio level is a big benefit of the structure. “If investors really like the way a particular manager does U.S. trades but are less enamored with the way the manager does international trades, they can have the exposures they want and avoid the exposures they don’t want,” he says.
Still, many FoMA managers report that most investors are simply looking for the peace of mind that greater transparency can provide — and managers stop short of using managed accounts to influence day-to-day trading. Indeed, Fortune’s decision to transition its fund-of-funds business to a FoMA structure was seen as an important way to appeal to its family office clientele, says founder Hopkins.
“Family offices are longer-term investors than the typical client, so control over liquidity is of less importance than transparency, which they see as a key to lessening fraud,” he says.
The added transparency that FoMAs provide, in fact, is helping drive new demand from investors that have traditionally been wary of hedge funds because of their secrecy — welcome news for an industry that is desperately looking to rebuild its asset base.
“Transparency was an area of hedge fund and fund-of-funds investing that we couldn’t get comfortable with — until funds of managed accounts,” says one client of Fortune who represents a major Canadian family office.
Even so, some funds of funds are reticent to adopt FoMAs not only because of the work involved in transitioning the accounts but also because of the additional due diligence that managers must perform, given all that access to trading activity. “The very transparency that investors are asking for puts the onus on funds of funds to analyze and make decisions as a result of the available data,” says Rishi Narang, founding principal of Marina del Rey, California–based alternative asset manager Telesis Capital, which invests some $65 million in mainly short-term quantitative strategies using FoMAs.
On the plus side, however, transitioning to FoMAs can help fund managers reduce transaction costs. Since the assets reside in a single custody account and underlying managers operate under a power of attorney to trade their slice of the funds, new money doesn’t need to be wired out to multiple managers. As Fortune’s Hopkins observes, “Using an old-fashioned fund-of-funds model is a costly exercise.”
