Exploring Fund Structure Customisation to Unlock Investor Capital

Fund managers are facing what is among the most complex and challenging fundraising climates of the past two decades. Ensuring effective access to capital means optimising fund structuring solutions to meet the evolving needs of allocators. Customisation can be the key to unlocking new markets for alternative assets and sustaining capital inflows.

Asset allocators’ available capital is often limited because of high exposure to hedge funds and private assets, as well as the decline in private asset cash distributions, which in turn provide proceeds for re-investment. In light of allocators’ limited capital to invest, managers need to be more flexible to attract what capital is there.

In such a fundraising environment, the managers that offer products and strategies that lend themselves to customisation will be better positioned to weather the present capital-raising environment and further develop relationships with the buy-side. Use of structures such as funds-of-one and managed accounts solutions can give fund managers a wider range of options to allow for a seamless fit between fund manager and allocator.

The Call for Customisation

Managers have been offering customised solutions for quite some time. Whether designed to accommodate an investor’s preferred allocation: e.g. overweighting or underweighting a given market, region or sector or including or excluding a theme such as ESG; customisation gives managers a way to develop a more holistic, strategic relationship with the investor.  In addition, customised products can be used to accommodate different fee, liquidity and expense terms and structures.

Sophisticated investors have been showing a willingness to pay structuring costs for customisation that meets their specific needs, rather than being a commingled investor among other allocators.

Differing investor requirements as it relates to liquidity, transparency, control, fees and expenses is not new. Accommodating such requirements and creating customised solutions, however, is becoming increasingly important to the capital-raising process. In addition, the need for customisation is increasing for other reasons. The widening gulf between investors, including investors in Europe and the US regarding ESG and DEI investments is one facet on which hedge fund and private asset managers have been seeing the fund customisation trend. Managers in Europe have been reporting calls from large EU allocators for Principal Adverse Impact disclosure requests to meet requirements under the Sustainable Finance Disclosure Regulation (“SFDR”), as well as any investor sustainability mandates. Conversely, some US investors, in a reflection of their regional political climates, have called on alternative investment managers for ‘carve outs’ from sustainability-related investments and commitments against incorporating ESG factors and from joining net zero initiatives. Furthermore, in certain regions managers may have differing views from those of their allocators and as such, are requiring customised solutions to exclude certain asset classes, markets or philosophies. When having to answer to interests that are sometimes diametrically opposed, a ‘one-size-fits-all’ approach will fall short. Developing customised solutions to accommodate the gamut of investor needs and preferences can illustrate nimbleness and ingenuity on the part of the fund – and of being receptive to investor goals.

Traditional structures may limit investment managers’ capacity to negotiate arrangements with allocators – and ultimately — raise capital under the present market conditions. There are nonetheless vehicles through which investment managers and allocators can enter customised mandates.  Structures such as separately managed accounts, funds-of-one and managed account platforms offer solutions that work for the fund manager and allocator alike.

Separately Managed Accounts

Large institutional investors have a history of partnering with investment managers to create separately managed accounts (“SMAs”) to create buffers for their portfolio holdings and enhance their liquidity profile, while exercising greater control.

SMAs helped to create a solution that avoided the liquidity and transparency constraints and fee terms of some fund structures. They allowed investors to enjoy the liquidity of their own holdings, enabled them to take advantage of market dislocations without their capital being used to meet other investors redemptions, improved portfolio transparency, and often enhanced communication and fee terms with the manager. SMAs can be easy to establish. In addition to the contracting process, typically they only require creating an additional account with the allocator’s existing custodian.

SMA structures can work well with strategies that are investing on a long-only basis in publicly traded liquid securities. They may, however, expose an investor to significant fee and agency risk in illiquid private assets. If held in the same name as the institutional investor, SMAs even may have the potential to expose the investor to liability risk beyond the value of the account. The SMA is also a poor fit if leverage or the use of a prime brokerage relationship is required.

While these structures can clearly be useful in some circumstances, in many cases other solutions may be better suited to the needs of investment managers and sophisticated institutional investors who require customisation. Alternative structures may also provide reduced risk, solve for operational complexity and improve governance for some alternative investment asset classes.

Funds-of-One

Funds-of-one are a strong choice as an asset management fundraising tool that can enhance alignment and engagement with investors. The structure allows investment managers to create segregated vehicles for allocator clients. It can accommodate, for example, an investment portfolio in private assets or a hedged strategy managed exclusively for the investor’s benefit based upon the investors requirements that also provides a comprehensive governance structure. In addition to accommodating the agreed customisation between the manager and the investors, these vehicles typically benefit from a range of independent regulatory, compliance and operational governance and oversight that does not always occur in a managed account. Operationally, funds-of-one tend to be more streamlined and scalable as they can leverage a similar infrastructure as the commingled funds offered by the manager.

In addition, the fund-of-one structure allows for easy tracking of investments and reporting customisation for the investor. The fund administrator working on the structure can provide detailed, aggregated reporting solutions as well as middle-office support and regulatory policy monitoring and compliance. The structure also allows for managers to utilise their existing prime brokerage relationships and scale other existing connections. This makes the fund-of-one an optimal tool for the delivery of an array of strategies to large allocators seeking a fully segregated vehicle that adheres to their policies and objectives.

Funds-of-One Platforms

For asset managers, multi-asset allocators (such as OCIOs and multi-family offices), sovereign wealth funds and other large institutional investors, the creation of a proprietary platform can provide the ideal structuring solution. These structures create a structure solution from the ground up to meet the specific needs of the platform owner and with which any manager or fund can integrate. In the case of an OCIO or multi-family office, fund-of-funds portfolios can be created for various asset classes and the allocation to these asset class specific portfolios can be based upon the specific needs and risk tolerance of the various family entities.

• Reporting: A managed account platform can enhance reporting transparency that becomes increasingly important in volatile market conditions. A service provider may create platform-level reports in addition to fund-level reports. These platform-level reports can aggregate information such as asset class and entity exposures across the entire platform, as well as provide detailed information on fees and expenses. Multi-family offices and OCIOs can provide their investors with detailed reporting of specific holdings and aggregated reporting across the platform. Risk reporting can be expanded to include correlation analysis of various platform components and scenario analysis, based on actual holdings.
• Liquidity: Investor liquidity generally is driven by a particular fund’s legal structure and redemption requirements. Managers usually try to match a fund’s liquidity terms with the liquidity of the underlying investments and the strategy that is being implemented. This liquidity match may be disrupted, however, during periods of dislocation when other investors’ need for capital forces managers to implement fund-gating provisions to protect fund holdings and investors. Under such market conditions, an investor who may be interested in buying into the dislocation may see muted results when trying to enter a fund as other investors are trying to exit. When allocators have their own platform, they can take full advantage of dislocations without impact from other investors or reduce their exposures when they are not being well compensated for risk. Multi-allocator platforms can also tailor their constituent’s portfolio liquidity based on their specific needs.
• Performance: The investment performance of allocators who own their own fund platform infrastructure may benefit from enhanced performance driven by improved cost structures, better portfolio information and risk management, as well as harnessing the structure’s full capabilities to take advantage of market dynamics and their own portfolios’ liquidity.

In addition, allocators could streamline contracting processes with investment managers on their platforms through Strategic Relationship Agreements (“SRAs”). SRAs could enhance the ability to take advantage of market dislocations and enable portfolio teams to spend more time on investments rather than contracting. These agreements also enhance alignment of interest and potentially can improve investment performance while lowering contracting costs.

The SRA model creates a broad relationship between a sophisticated allocator and an asset manager who may offer a variety of strategies. It allows the investor to review its manager’s direct investment, co-investment or fund recommendations and accept or reject any investment, fund or strategy presented by their asset managers. It provides investors the opportunity to evaluate recommendation vis-à-vis their present allocations, the opportunities available and the impact on their portfolio as a whole. The arrangement makes the fund manager essentially a fiduciary with regards to an investor’s risk profile and targets. Once the SRA is in place, the SRA takes precedence over individual fund or deal fees and creates an aggregate fee level including for performance and incentive fees across all strategies and structures. The asset manager’s performance is gauged across the investor’s entire relationship of funds, direct investments and strategies to which the investor has allocated. Moreover, the SRA is typically approved by an allocators governance committees and typically does not require the governance committee to approve each underlying investment (direct, co-invest or fund investments) which in turn lets investors be nimbler in taking advantage of opportunities in the market. Investment managers can get a strong benefit from the broader relationship by helping the investor to allocate capital wherever it is being best compensated for the relative risk.

What to Consider in Fund Customisation

When managers and allocators build customised solutions having the right support team in place is critical. Having the right legal, regulatory, compliance, governance and operational expertise and advice is critical to make informed decisions that will set the stage for collaboration between the investment manager and allocator. Service providers should bring the requisite experience in liaising with investors and managers on customised solutions as well as the operational expertise and technology platform to provide efficient and scalable operations that bring each investor’s unique requirements into consideration, whether that be exposure limits / exclusions, specific fee calculations or netting, liquidity and transparency terms, or other investor mandates.

The Maples Group Difference

The Maples Group provides a suite of client services spanning middle and back office, fiduciary, regulatory and compliance and legal services. Our model provides institutional investors and fund managers with access to a broad array of expertise to assist in designing and operating a wide set of customised structures.

For decades, the Maples Group has leveraged its award-winning expertise and proprietary technology to create solutions that facilitate capital flows between investors and managers.   We have deep experience providing support to a broad set of investment structures and investment strategies and across hedge funds and private assets strategies Our local teams are backed by an extensive global network of colleagues, which allows us to service clients across time zones and jurisdictions. Drawing from our history of client excellence, we have the flexibility and creativity to develop client solutions as regulation advances, investment strategies change, funds grow, and operational requirements evolve.

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