The Hindu Business Line : UMAs: Delivering multi-style exposure through individual accounts

Can HNIs can be offered multi-style products that include mutual funds, hedge funds and direct investments within a single portfolio? Unified Managed Accounts may be the answer.

B. Venkatesh

Last week, this column discussed fund-of-funds. Specifically, it showed how fund-of-funds can act as a conduit for offering tailored investment solutions using single asset-class funds as the building blocks.

In response to that article, some clients wanted to know if HNIs can be offered multi-style products that include mutual funds, hedge funds and direct investments within a single portfolio structure.

This article discusses the characteristics of such a portfolio. They are called Unified Managed Accounts and are new generation products in the separately managed accounts industry.

Unified, they stand

In a fund-of-funds structure, the portfolio manager collects money from the investors and allocates it to various single asset-class funds.

A fund-of-funds manager, for instance, would allocate money to a large-cap index fund, a mid-cap active fund, a long-term bond fund and an arbitrage fund. The skill of the fund manager lies in manager-selection- selecting managers in each category who can deliver returns in excess of the benchmark index (alpha returns).

Unified Management Accounts (called UMAs) also carry a two-tiered structure. Assume 25 investors park Rs 25 lakh each with the portfolio manager of a UMA structure.

Further assume that the portfolio manager proposes to take exposure to large-caps, mid-caps, long-term bonds and arbitrage strategy.

The portfolio manager may decide take beta exposure to large-caps through low-cost index funds. The manager may, however, take a view that a certain mid-cap manager can generate excess (alpha) returns in the mid-cap space. The UMA manager will, therefore, allocate assets to the mid-cap-style manager for direct equity exposure in that space.

With direct exposure in bonds only possible for mutual funds and banks, the manager will chose to invest in an alpha-generating bond fund. The UMA manager may hire a portfolio manager to engage in spot-futures arbitrage instead of investing directly in an arbitrage fund.

The UMA, thus, provides an investor a single-window exposure to multi-style managers. The UMA manager is called an over lay manager.

She oversees client management, deciding the optimal asset allocation policy and ensuring that client-specific horizon objectives are achieved.

Optimal structure

The UMA provides two distinct advantages over the fund-of-funds structure.

One, UMA operates as a separately managed account (SMA) structure. And two, it distinguishes model decisions from client-specific decisions.

Consider the first factor. A fund-of-funds takes exposure in other mutual funds. This could lead to sub-optimal investment. Here is why.

Suppose the fund-of-funds invests in a mid-cap active open-end fund. The mid-cap manager will have to maintain cash equivalents to meet redemption requirement from unit-holders. This leads to a cash drag — lower returns that cash equivalents will earn compared with the mid-cap stocks in the portfolio.

Contrast this with a UMA that has 25 investors. The overlay manager will operate 25 different accounts, which individually hold index funds, mid-cap stocks, long-term bonds and spot-futures arbitrage strategy. One investor’s decision to move some assets into cash will not affect other investor accounts. This allows the overlay manager to efficiently custom-tailor portfolios.

Consider the second factor. A model decision is an active management decision — the mid-cap portfolio manager deciding to sell BEML, for instance, and taking exposure to Gillette. The model decision relates to all portfolio accounts that the overlay manager has assigned to the mid-cap manager.

One investor among the 25 may, however, have a constraint in taking exposure to MNC stocks. The overlay manager (UMA manager) will then ensure that that particular investor’s account does not have exposure to Gillette.

The UMA structure, thus, combines the benefit of fund-of-funds and SMA in that it offers multi-style investments through collective vehicles and direct investments and also provides the flexibility of SMAs.

Importantly, UMA does tax-efficient investments in each client account.

The tax-efficient UMA structure sits well within the core-satellite framework. The overlay manager can construct low-cost beta core through index funds and alpha-satellite exposure through several outside multi-style managers.

Conclusion

The UMA structure is a new generation product in the separately managed accounts industry. Some asset management firms in the US have moved to the next generation product called Unified Managed Household which is a UMA structure along with other assets such as collectibles and real estate.

In India, offering such structures is a problem at present because the asset management industry has not thought it fit to promote style investing.

While exposure to an active mid-cap manager is easy, it is difficult to find a large-cap value or small-cap growth manager; for most managers simply follow multi-cap multi-style strategy within one portfolio.

A paradigm shift in asset management industry can lead to UMA offerings first to HNIs and later to retail investors. Then, investor interest will be better served.

(The author is an investment strategist. He can be reached at enhancek@gmail.com)

More Stories on : Investments | Stock Markets | Micromotives

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page