In the aftermath of the financial crisis, customized investment vehicles have become popular alternatives to traditional fund structures for allocators seeking greater control over their invested capital. Redemption pressures led to the imposition of gating provisions and compromised liquidity terms, propelling counterparty risk to the forefront of investor concerns. As such, many institutions have reconsidered their approach to investing in commingled funds by adopting various solutions to segregate their assets from other investors such as managed accounts and fund-of-one.
Two specialized product offerings that have seen increased use in recent years are managed accounts and fund-of-one structures. In fact, almost half of all respondents to a 2015 KPMG Global Hedge Fund Survey have said that they already offer a fund-of-one or managed account solution in direct response to growing demand. As a companion piece to our previous post on the managed accounts landscape, this article will examine funds-of-one, their potential advantages and disadvantages, and how they differ from managed accounts.
Ownership and Liability
As the name suggests, a fund-of-one is a fund with one dedicated investor. At first glance, while funds-of-one may seem similar to managed accounts in regards to the benefits they provide to investors, the biggest difference between the two lies in who ultimately owns the assets. In a fund-of-one, assets of the entity are legally owned by the manager of the vehicle as opposed to the limited partner. This difference in ownership brings several potential advantages, one of which is a greater degree of liability protection for the investor. Investors in managed accounts, on the other hand, have to be cognizant of possible liability exposure brought on by employing leverage or entering derivatives.
Reduced Costs
Another potential advantage of limited ownership is an overall reduction in ongoing operational costs of the fund. The costs of investing through managed accounts without a third-party platform can run high; investors are responsible for setting up service providers such as prime brokers, custodians, and fund administrators. All commingled funds are able to achieve economies of scale by leveraging a wider investor base to reduce operational costs. The initial cost of setting up a fund-of-one structure can be higher due to initial operational issues, than that of allocating to a commingled fund. However, the manager is directly responsible for maintaining administrative relationships. This minimizes operational burden and removes many of the esoteric tasks of running a fund, which can end up becoming quite difficult to manage without the proper resources in place. Fund-of-one structures therefore represent an alternative option for institutions and family offices who have the wherewithal to invest in customized products but do not want to deal with such administrative tasks.
Customization, Transparency, and Liquidity
While limited ownership contributes to many of the advantages of using a fund-of-one structure, investors are still beholden to the manager’s terms. Unlike managed accounts that provide complete position transparency and daily liquidity, funds-of-one are somewhat limited in this regard due to the fact that assets are owned by the manager. Additionally, all commingled funds are able to achieve economies of scale by leveraging a wider investor base to reduce operational costs. However, terms surrounding lockup and position transparency are negotiable since the fund is dealing with a single investor. Funds-of-one are customized vehicles, and as such, investors may be able to arrange more favorable terms at the outset as opposed to accepting universal terms offered by the fund manager.
Despite some of these restrictions, institutional investors with mandates and highly specific portfolio restrictions may benefit from the increased oversight that a fund-of-one provides. Governance provisions and clear guidelines within the investment management agreement are usually established beforehand, but these can be adjusted as an investor’s circumstances or strategic focus change. This provides a level of flexibility not found in “off-the-shelf” commingled investment products.
Securities offered through North Capital Private Securities, Member FINRA/SIPC
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