The Rise of Hedge Fund SMAs - How to Capitalize on Investor Demand
By SS&C
Hedge fund separately managed accounts (SMAs) have grown increasingly popular with investors in the past few years. As a result, many hedge fund managers are joining SMA platforms and adding SMAs to their offerings. In the process, they are running into significant operational complexities that make managing SMAs at scale very different from running a conventional hedge fund. This paper explains the benefits of SMAs as well as the challenges they pose, and what managers need to take advantage of this growing trend.
By all accounts, hedge fund separately managed accounts (SMAs) appear to be having their moment. The Alternative Investment Management Association calls it a “renaissance,” observing that SMAs have “evolved from a niche allocation vehicle to a method of preference for deploying capital by institutional investors.” At a recent AIMA forum, JP Morgan predicted that 58% of new fund launches in the year ahead will be SMAs, while Goldman Sachs projects the SMA space to grow by $400 billion by 2027.1
The appeal of SMAs is understandable. In contrast to a conventional commingled hedge fund structure, a hedge fund SMA gives a single investor exposure to a hedge fund manager’s strategies—and the potential for exceptional returns—combined with direct ownership and control of the assets in the fund. SMAs allow for customization to investor mandates—for example, ESG-based selections or exclusions, risk parameters, tax strategies, limits on leverage or derivatives, or other criteria. Moreover, investors can negotiate customized fee structures, which typically do not include a performance component. And, with no lock-up periods or redemption windows, SMAs afford investors greater flexibility in liquidity.
In a recent BNP Paribas survey of institutional allocators, 26% of respondents said they use SMAs among their hedge fund allocations, while 15% said they expect to increase their allocations to SMAs.2 Hedge fund managers are moving quickly to respond to this growing investor demand, particularly as fundraising for pooled vehicles becomes increasingly competitive and challenging. From a manager’s perspective, set-up is less complicated, since an SMA does not require a legal-entity wrapper. Hedge fund SMA platforms have proliferated in recent years to more efficiently connect investors and managers in a streamlined manner.
SMA platforms also perform many investor onboarding and servicing functions, freeing the manager to focus on strategy and work with the client on investment decisions.
OPERATIONAL COMPLEXITY
For all the optimism and energy around this segment, however, running SMAs carries significant operational complexity, especially for firms looking to offer this capability to multiple investors at scale.
Institutional investors have high standards of governance and oversight. SMA managers must be able to demonstrate operational integrity that can withstand rigorous due diligence, with institutional-grade controls, strong cybersecurity and measures to mitigate counterparty risk.
THE ROLE OF A FUND ADMINISTRATOR
A third-party fund administrator can play a critical role in enabling managers to scale SMA operations efficiently, and should be able to relieve much of the complexity associated with servicing multiple accounts. As with the prime broker, the selection of an administrator for an SMA is up to the investor. In practice, however, investors are likely to rely on their managers’ experience and recommendations. The SMA is more of a collaborative relationship between the investor and manager than a typical pooled fund, grounded in a high degree of trust and confidence.
An SMA is not too dissimilar from a regular hedge fund from an administrative servicing standpoint. However, there are some nuances to take into consideration.
SMAs require an infrastructure that can handle accounting and reporting for several individualized accounts. Among the biggest challenges:
Transparency and reporting: Greater visibility into fund holdings and trades is a key reason investors will choose an SMA over a commingled fund. Where a manager of a conventional fund can simply issue monthly statements, SMA investors will expect more frequent and detailed reporting—daily, in some cases—on performance, attribution, risk and other bespoke requirements. This will require aggregating data from multiple sources and delivery of custom reports for every investor via client portals or dashboards.
Prime broker: SMA investors can choose their own prime brokers, which means the manager is likely to have several prime broker relationships instead of just the one or two associated with conventional hedge funds. This puts the onus on the manager to reconcile across multiple prime brokers and counterparties.
Post-trade allocations: Managers must ensure that trades are allocated fairly across all accounts. This requires having systems that can track the entire trade lifecycle and automate allocations while ensuring compliance with each account’s investment guidelines.
Compliance: Managers must be able to meet regulatory reporting and investor disclosure requirements across multiple SMAs.
The key considerations in selecting an administrator include:
Technology infrastructure: The administrator must have a highly scalable infrastructure to handle multiple individual SMA books—the key difference between SMA and pooled fund accounting. The accounting system should offer look-through capabilities that enable visibility into portfolio data and activity. Connectivity with prime brokers and all the major SMA platforms is also critical. And because SMA managers are in possession of highly sensitive client data, the provider needs to have strong cybersecurity controls.
Reconciliation: The administrator can take a major back-office burden off the manager by performing trade, position and cash reconciliations with every SMA’s prime broker.
Custom reporting: The provider should be able to deliver comprehensive, customized performance, attribution and risk reporting for each individual account, ideally via secure client portals. SMAs don’t normally have a daily NAV calculation like a pooled fund, but the administrator should be able to provide portfolio valuations for each account. The provider should also have the capability to handle customized fee schedules and calculations.
Compliance monitoring: The administrator should be able to perform automated, rules-based checking against investor mandates, including any restrictions, sector weightings, ESG or other criteria spelled out in the investment agreement.
Hedge fund SMAs are clearly gaining traction. Their influence in the alternative space is only likely to grow, as allocators increasingly signal their preference for individualized investment solutions. Expertise in SMAs provides hedge fund managers with an opportunity to diversify their offerings, deepen relationships and capture more allocations.
What’s needed to succeed is a true data and
operations partner that can alleviate much
of the administrative complexity that comes
with managing and servicing multiple SMAs.
With the right combination of technology, scale, service capabilities and expertise, managers can better position themselves to take full advantage of this growing trend.
SS&C
SS&C is a leading innovator in technology-powered solutions and operational services for the global investment management industry, with particular expertise in the full range of alternative investments, including hedge funds and SMAs, private equity, private credit, funds of funds, real estate, real assets and direct investments. We are also the industry’s largest global fund administrator as measured by assets under administration.
SS&C develops, owns and operates the technology that powers our fund administration services. We continually reinvest a significant percentage of our annual revenue into technology research and new solution development. SS&C serves a worldwide clientele with a network spanning the major financial centers of North America, Europe, Asia and Australia.
Learn more at ssctech.com
