In our last post, we highlighted a key difference between separate managed accounts (SMA) and funds-of-one. By virtue of a power of attorney granting authority to a fund manager to trade assets of an account, the account owner can terminate the power of attorney (POA) at any time, with little recourse left to the fund manager other than hoping to recoup start-up expenses incurred in establishing the SMA. This is so even though the investment management agreement governing the SMA may have specified a very different set of termination rights and obligations. As between the POA and the investment management agreement, the POA is given greater weight on the basis that general principles of fiduciary duty would not generally permit a fund manager to compel an investor to have an advisory relationship with the fund manager

Assuming that our fund manager is willing to manage the investor’s assets in an SMA, the anticipated terms of the investment management agreement governing the SMA will provide for: 

• enhanced portfolio transparency and a better look into the fund management company; and

• superior portfolio liquidity rights compared to liquidity rights in a commingled fund.

In this post, we’ll deal with issues relating to transparency, and later, turn back to issues relating to liquidity rights. At its most basic meaning, transparency allows investors to see what the manager is doing with their money. At the portfolio level, SMAs provide an investor with position-level transparency (which may include position limits, position accountability, reportable position levels, customized risk analytics) while other SMAs provide data on the top positions that have the potential to move the needle. Enhanced transparency becomes important for smaller, niche focused strategies but is also important to larger institutions investing in hedge strategies who require certain tilts to a portfolio.

Assuming you enter into an SMA with an investor seeking enhanced transparency, you may be wondering if you should disclose the existence of the SMA to investors in any/all of the commingled funds you manage.

The answer is: yes! In fact, it has been said that a fund cannot provide transparency without disclosure. It’s also been said that a weakness of SMAs is that they rarely achieve the goal of transparency. But, we’ll leave that for another day.

And what your disclosure should be depends in large part on whether a non-disclosure agreement or the SMA incorporated a non-use provision, as well as the contours of that provision. But, that’s not the end of the story because even if experienced counsel insisted on incorporating a non-use provision in the relevant agreement, the owner of the SMA can still take actions that harm investors in a commingled fund(s) that you’re managing. 

This series of posts will examine the particular challenges posed to managers when managing a managed account alongside a hedge fund, in particular, conflicts of interest that often arise when a manager is managing a client account that implements or overlaps with a material number of securities held by the hedge fund. Along the way, we’ll suggest best practices to manage these conflicts. More to come on this! Watch for our next post.