Demand Increasing for Separately Managed Accounts
Faced with gates, suspension events and other redemption restrictions in pooled investment vehicles, investors are increasingly approaching investment managers to establish separately managed accounts (“SMAs”). SMAs are individualized investment portfolios that are separately managed for each investor by an investment manager. Historically, given the administrative burdens involved in managing an SMA (including additional reporting obligations), investment managers were inclined to establish SMAs for only their largest clients, such as pension funds, endowments and funds of funds. However, investment managers now seem willing to organize SMAs for smaller investors as they watch investor capital dissipate through redemptions and face an increasingly difficult fund raising environment. An SMA offers an investment manager the opportunity to accommodate each client’s specific needs without the same level of conflicting obligations to other clients and, as a result, an investment manager may offer an investor preferential reporting, liquidity or economic terms without the same level of concern about “most favored nations” provisions with other investors. In light of these considerations and the current climate, a growing number of SMAs are being established by investment managers for contributions of as little as $50 to $100 million.
An SMA is typically structured as either an “Investment Account” or a “Separate Vehicle.”
- In the case of an Investment Account, an investor typically contributes cash, securities and/or other assets into an account established on behalf of the investor for management by the investment manager, or the investor extends direct discretionary authority to the investment manager in respect of existing assets. The relationship between the investor and the investment manager is governed by an Investment Management Agreement.
- In the case of a Separate Vehicle, the investment manager creates a special purpose investment vehicle with the investor as the sole limited partner or shareholder. The investment manager typically controls and manages the Separate Vehicle under the terms of the constituent documents of the Separate Vehicle (including an Investment Management Agreement), and the Separate Vehicle maintains direct ownership of the assets.
- From the perspective of the investment manager, an SMA structured as a Separate Vehicle may be preferable to an SMA structured as an Investment Account for a number of reasons.
Commonly Negotiated Terms: Investment Mandate and Fees
In general, an investor and investment manager will negotiate the investment mandate of the SMA. In many cases, the investor negotiates detailed written investment guidelines to ensure that the investments are consistent with the liquidity and return characteristics associated with the investor's investment objective. In addition, the fees associated with an SMA often include both management fees and incentive fees (or incentive “allocation” with respect to an SMA structured as a Separate Vehicle). The investor may bear an annual management fee equal to a certain percentage (often between 0.5% and 2%) of the net asset value of the assets attributable to the SMA. If the investor terminates the SMA or makes withdrawals from the SMA within a certain period of time after formation (for example, 12 to 18 months), the investment manager may be entitled to an additional management fee equal to the management fee (calculated based on the original contributions to the SMA) that would have been payable by the investor for such period of time had the SMA not been terminated or withdrawals not been made. The investor may also bear an annual incentive fee or allocation equal to a certain percentage (say 5% to 20%) of the net profits of the SMA. The incentive fee or allocation is typically subject to a “high water mark” and, in some cases, a hurdle rate or preferred return (which may be linked to a relevant benchmark).
The Investor's Perspective: Transparency and Liquidity Advantages
From the perspective of an investor, an SMA offers the investor its own tailored fund with greater transparency and fewer restrictions on liquidity. With respect to transparency, reports provided to an investor are often customized to satisfy the specific needs of the investor. An investment manager and an investor generally agree on precisely the type of information that will be provided to the investor on a daily, weekly, monthly, quarterly or annual basis. The investment manager may be required to report to the investor all transactions involving the investment assets, a list of all accounts, the investment performance of the portfolio, the net asset value of the SMA and related information. With respect to liquidity, an SMA may offer an investor daily, weekly or monthly liquidity terms (without lengthy notice periods, gate provisions, lock-up periods and other similar features typical of hedge funds). In many cases, an investor is able to withdraw all or any portion of the assets from the SMA upon prior notice to the investment manager (anywhere from 5 to 90 days depending on the nature of the investment assets).
Given the current economic climate and the issues that both investors and investment managers are confronting, an SMA offers an alternative investment form for which both investors and investment managers are showing increasing willingness and demand. Investors and investment managers should familiarize themselves with the potential structures of an SMA and commonly negotiated terms.
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