AlphaMetrix highlights counterparty and asset safety risk in managed accounts platforms
The main selling points for managed accounts since the acute phase of the financial crisis in 2008 introduced investors to gates and other inhibitions are transparency, liquidity, high levels of governance and diminished co-investor risk.
While growth in managed accounts since 2009 looks solid, it is not spectacular. Furthermore, investors are now questioning just how safe the model is in light of the cash flow difficulties unfolding at AlphaMetrix, the Chicago-based managed accounts platform.
AlphaMetrix was instructed last week by its regulator – the National Futures Association (NFA) – to repay $600,000 owed to its external managers by 1 November 1 2013, or face a trading ban. The company has said it is co-operating with regulators.
The exact circumstances leading to the cash flow issues at AlphaMetrix remain unclear. What is known is that AlphaMetrix cross-subsidised a number of its business lines. As the parent company struggled to meet revenue targets, fee rebates to the managers on the AlphaMetrix commodity pool were delayed.
This came to light when CME Group and the NFA decided to terminate their relationship with AlphaMetrix 360, a unit of AlphaMetrix they recruited to perform daily checks on the balances that futures brokers were holding in customer accounts. The subsequent leak of a letter from the AlphaMetrix CEO to its commodity pool participants, in which a reference to cash flow issues was made, caused further concern.
Managed accounts experts are predicting that managers will leave the AlphaMetrix platform and that investors will redeem. Fortunately, the managers on the platform trade in highly liquid futures contracts so the likelihood of a fire sale of assets, leading to a precipitate drop in value, is low. There is no risk of investors being unable to redeem because client assets are not held at AlphaMetrix but by custodian banks and clearing brokers (futures commission merchants, or FCMs).
The implications for the AlphaMetrix business as a whole have yet to become plain, but expectations are positive. One prime broker predicts it will survive, but under different ownership.
Institutional investors with exposure to managed account platforms should now be asking themselves some searching questions. A number of allocators appear to believe that managed accounts cannot fail. This is imprudent. Managed accounts have and will fail. PlusFunds - which was forced into a sale out of Chapter 11 in 2006 on the back of its exposure to the failure of Refco in 2005 - proved that eight years ago.
It is unlikely that regulators will clamp down on managed account platforms now. But operational due diligence teams at institutional investors will be rigorously re-examining exactly where their assets are held by these platforms. One managed account provider is already fielding these questions from investors, indicating they are alert to the issue.
The second lesson for investors is to assess in more detail how strong the other business lines are at managed account providers. If they understand the financial strength of platforms, their asset safety and custody arrangements, and the cross-subsidies within platform businesses, they can continue to allocate to managed accounts with confidence.