This articled originally appeared on LinkedIn: “Asset Management as a Service” – (AMaaS) – What is it and when & why to use an External Fund Manager? written by Aseem Arora.
All investors, especially Institutional & Corporate Investors, Independent Asset Managers (IAMs) & Family Offices are under pressure to improve (a) risk management and (b) returns on their investments. All investors have limitations as to the width of the securities that they can monitor and track: especially fixed income securities, because of the extremely fragmented nature of the market and the numerous series of securities. This fragmentation yields ‘extra’ profits, but requires bandwidth to sieve through a mountain of data.
For example, a bond which is due for redemption in 8 months may quote at significant discount due to uncertainty of another series of the bonds for the same issuer due after 3 years, whilst the issuer may have sufficient cash in the bank to honor the short maturity bond. Depending on the risk appetite of the investor, he may like to buy the short maturity bond naked, or may sell CDS on the bond, or may take leverage to enhance the returns: this requires careful risk management and balance-sheet management (asset-liability mismatch, capital adequacy, etc.).
Most institutions have an in-house treasury team, which are excellent in their limited sphere of day-to-day funds-flow management but typically have limited bandwidth for investment management. This market gap is filled-in by (a) closing the eyes (and many do!), (b) having an army of personnel in the treasury department (where the investible funds exceed billions of dollars), or (c) using specialized institutions (which entails high cost of fees and ‘counter-party’ risk).
Fortunately, smart investors are increasingly using another way (d) Asset Management as a Service (AMaaS): wherein an external fund manager works as “in-house” investment team without creating (additional) counter-party risks. Additionally, this structure enables the institution’s in-house team to ‘learn’ new opportunity sets, use robust pricing models, create appropriate investment structures, understand risk management (position monitoring) and enlarge the execution capability of the institution across large spectrum of securities.
Benefits of using an External Fund Manager
- Earn Higher Returns
A specialist fund manager’s ability to identify and source securities would enable the investor to generate significantly higher treasury/investment income. The returns can increase multi-fold due to intelligent use of leverage combined with clever structuring, wherein the risk can be contained in a SPV (special purpose limited liability companies) without recourse to the investor. In most cases, the cost of leverage would be low due to the fund manager’s sizable existing relationships with the banks.
- No Additional Counter-Party Risk
All the investor’s assets, be it cash or securities, can be held in the investor’s name, with the custodian of investor’s choice. The external fund manager can assist the investor to design the portfolio, assist in execution, monitor the portfolio on real-time basis, though no assets flow through the fund manager’s accounts. Thus, the investor does not take additional risk on the traditional fund manager, hence there cannot be any problems of raising the gates or any way preventing exit from any security.
- Tax Efficiency
The fund manager can help the investor in clever deal structuring that not only reduces the risks but also enhances tax efficiency. Depending upon jurisdiction, the fund manager can assist in designing structures to improve your after-tax returns. For instance: Interest income at SPV (in tax-free jurisdiction) could be up-streamed to the fund company as capital gains which attract nil/lower taxation.
- Larger Catchment Area
The fund manager can have an established network of multi-tier relationships with various market participants which can enable it to source securities at attractive terms. The investor would be able to piggyback on the fund manager’s network without the time and resources required to build it ab initio.
- Regulatory Approvals
Since the fund manager will have the necessary regulatory approvals in various jurisdictions, the investor can effectively leverage it to develop “his/her/their” foundation for launch of independent fund management business in future.
- Lower Capital Adequacy Requirement
The fund manager may have been successfully raising leverage on individual securities and/or SPV’s to enhance the overall portfolio returns and can leverage its network with global banks to obtain leverage which is not only cheaper but more importantly can be ring-fenced to specific securities and/or SPV without recourse to un-leveraged portfolio or your balance sheet. Thus, the investor can earn superior returns without the requirement for additional capital reserves.
- Constant Monitoring and Reporting
The specialist fund manager may have developed sophisticated systems for real-time monitoring of the portfolios; this may enable them to optimize the entry and exit time and price, as well as monitor risks (including pyramiding, trailing stop loss, absolute stop loss, look backs, etc.). This is a very critical activity to reduce risk in any portfolio: both in times of low volatility (to capture deltas) and in times of high volatility (to avoid unacceptable losses). These advanced monitoring and reporting tools can be extended to the investors, without requirement of additional resources or costs.
- Dedicated Team
The fund manager will usually have a team of professional managers devoting full time and attention to managing the portfolios. Hence, they could watch and access broad spectrum of markets and securities far better than those who do investment on “part time” basis or as “additional” responsibility. As with any endeavor, specialization yields superior knowledge, contacts, access to investment opportunities, infrastructure, resources, and experience. For an investor to create similar structure would cost time, resources and (learning) opportunity costs.
- Access to adequate market information
It takes time and resources, including cutting-edge technology, to stay abreast of the market. Information sources, like Bloomberg, provide basic market information, but it requires proprietary models to convert basic information into actionable knowledge. Besides market information sources, the fund manager will usually have installed network of experts, intermediaries and industry relations which can enable them to take critical investment decision ahead of the masses. This can provide an edge to the investor’s portfolio.
- Specialized Capabilities and Economies of Scale
The fund managers usually employ many investment strategies (including quant strategies) that are simply not available to most in-house treasury managers who have many other responsibilities. In fact, their expertise could allow the investor to broaden his/her/their investment guidelines beyond the comfort level they may have with in-house management. The investors can also enjoy benefits of economies of scale not always available to part-time managers (such as preferential showing of offering, preferential rates, priority execution, etc.). Their network partners would look at the total business which they bring to their table, rather than only ‘the investors’ potential business, hence the investor would enjoy trading efficiencies, access to market information, and investment opportunities that may not always available to them.
In summary, an investor can have access to the external fund manager’s professional expertise in fund management to design an optimum portfolio, to structure the investments in a tax-efficient manner, with ring-fenced leverage to enhance the returns, and a robust monitoring system for risk management & profit optimization. All this, without the huge set-up costs or time involved, practically: on a pay-as-you go model, with complete control over the assets. Thus, obtain higher risk-adjusted returns net of management costs.