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In the wake of the 2008 global financial crisis, some institutional investors began to rethink their allocations to commingled hedge funds. While many of these allocators sought continued exposure to hedge fund-type strategies, they looked for ways to minimize the risks to which they had acutely become exposed in 2008 and the years that followed, including the inability to redeem their investments for cash within the expected timeframe, as well as the co‑investor adjacency risk that results from being an investor in a commingled fund. During this time, a related phenomenon was taking hold. The power dynamic between investment managers and allocators began to shift, with allocators enjoying greater leverage during their negotiations with fund managers.
Both of these events led to an increase in institutional investors’ use of customized products to access hedge fund-type investment strategies, mainly in the form of managed accounts and single investor funds. Many fund managers conceded to these requests, provided that the allocations were sufficiently large to justify the additional operational complexities that arise from managing multiple client accounts.
This three-part series examines why the management of both a commingled fund and a managed account with the same – or similar – investment strategy presents conflicts of interest for a fund manager. This first article explores the increased use of separately managed accounts by institutional investors; ways that separately managed accounts differ from single investor funds – commonly referred to as “funds of one”; and the general conflicts of interest that can arise for an investment manager when managing multiple client accounts. The second and third articles will discuss in detail the primary conflicts of interest – including those arising from differences in transparency and liquidity rights between a managed account client and an investor in a commingled fund, as well as conflicts relating to trade and expense allocations – and suggest several best practices for managing those conflicts.
For more on conflicts of interest, see our three-part series on the simultaneous management of hedge funds and private equity funds: “Investment Conflicts” (May 7, 2015); “Operational Conflicts” (May 14, 2015); and “How to Mitigate Conflicts” (May 21, 2015).