Separately Managed Account Program Becoming More Popular
It used to be, even just last year, that separately managed accounts were only offered in rare circumstances and only to a very select few investors. However, an increasing amount of managers are offering their hedge fund programs to investors through a separately managed account (SMA) platform. Market forces are pushing managers for more transparency and the managers are looking toward SMA programs more and more.
Background of the SMA
Basically a SMA structure is simply a managed account structure that many registered investment advisors used prior to the increased popularity of the hedge fund structure. In essence the manager has a power of attorney to trade the investor’s account. The investor retains many more rights in this structure and has more transparency into the underlying account, see hedge fund separately managed accounts.
As more and more frauds are discovered, transparency will become an even greater issue for investors. Due diligence should, likewise, increase.
Issues for the Manager
There are a couple of issues that the SMA platform presents to hedge fund managers. First, the manager will not be able to receive favorable tax treatment on its performance fee. One of the most desirable aspects of the hedge fund structure is that the manager can receive tax advantageous characterization on its performance fee (performance allocation) if the fund has underlying long term capital gains. With the SMA structure the performance fee will be taxed as ordinary income to the manager because there will be no “allocation” of the profits (because the SMA structure is not a partnership or taxed as a partnership).
The second issue that the manager should be aware of is that the SMA platform allows the investor insight into the manager’s proprietary trading program. Another central advantage of the hedge fund structure is that managers can keep their proprietary trading program secret. Investors in a fund generally will have no right to see the fund’s trades or inspect the fund’s assets. In a SMA the investor has complete transparency into the assets and the trades. While investors are seeking such increased transparency, the manager will need to weigh the marketing benefits of the platform against the potential downfalls.
Another issue is that the manager may potentially be subject to hedge fund registration if the amount of SMA clients exceeds either 5 (at the state level) or 15 (at the federal level). See also Issues with the SMA structure. A manager should discuss this issue with his hedge fund attorney.
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