By Cliodhna Murphy
In the wake of the 2008 global financial crisis (“GFC”), the requirements for transparency, control and customization across entire investment programs became all the more apparent. Amidst the call for these industry changes, separately managed accounts (“SMAs”) became a popular portfolio structure that offered investors many of the freedoms they were looking for. In parallel, consideration of environmental, social and governance (“ESG”) factors has become a mainstream topic of investment discussions across the world, and responsible investment practices and evaluation criteria have had an increasing influence on how investment decisions are made.
Now, as we navigate the COVID-19 pandemic and the current crisis both inside and out of the financial sector, it is worth reflecting on the factors which have driven the increased popularity of SMAs and exploring whether these vehicles could see a rise in popularity as a means of accessing ESG strategies. Through examining these factors, we can explore whether the demand for these vehicles may be impacted by COVID-19 and whether SMAs could become the structures of choice for ESG-savvy investors.
As calls for greater transparency mount, partly as a result of the natural evolution of the market and partly as a reaction to events, technology has kept up with growing demand. Full transparency of position-level data for alternative investments has historically been costly and cumbersome. However, there are now cost-effective technology solutions to efficiently process the extra data that arises as a result of the demand for full transparency. By carefully managing the complex additional data, risk management and performance analytics are strengthened, which can help with both portfolio construction and ongoing monitoring.
Transparency is crucial for investors who are looking to measure ESG considerations across their entire portfolio. To date, there has been a marked focus on ESG considerations within publicly listed companies, while private markets currently lag behind. However, for effective ESG scoring across an overall portfolio composition, allocations to alternative assets cannot be ignored.
We continue to see methods for collating ESG data evolve and improve, as greater collaboration sets clearer standards and definitions, and concerted efforts by all parties across the investment ecosystem drive positive change. But none of these factors can be monitored or measured by investors without underlying transparency on what exposures their portfolios are taking. Because of this, investors are likely to gravitate towards more transparent investment vehicles such as SMAs to continue holding themselves to the high standards they look for in the companies in which they invest.
SMA structures offer a number of important control features that are not available through the use of commingled investments. First, they are by definition segregated, thereby removing co-investment risk and increasing oversight. Legal ownership of the assets in an SMA rests with the single SMA investor, so these structures offer significantly higher protection than commingled vehicles in the event of a default.
Particularly of interest for investors who are looking to apply ESG criteria is the ability for investment guidelines to be customized using SMA structures. Investors also have greater control over the liquidity of the underlying assets within SMA structures and can pivot more easily between lending and borrowing, which is especially important during periods of market stress.
These characteristics helped propel SMA structures into the limelight post-GFC and may do so again following the COVID-19 related market volatility we have seen in this year.
One of the key reasons SMAs saw so much interest post-GFC was their ability to individually tailor liquidity terms for each portfolio. The process of setting up and customizing an SMA often brings managers and investors closer together and leads to more frequent and meaningful dialogs. Coupled with the additional transparency that SMAs offers, this expanded communication often leads to allocations that tend to be longer-lasting. Therefore, although liquidity terms may allow for swifter exits, in practice this isn’t always the case.
As we continue to navigate the economic impact of the COVID-19 pandemic, investors are likely to call for more transparency, control and customization, and to continue the drive towards responsible investing. Fund managers eager to successfully seize new opportunities will be ready to meet these demands.
SMAs deliver the required features and allow investors to design their own ESG bespoke products, which can be independently monitored at a position level. Asset servicers play a valuable role to help collect and collate information from private firms to help both investors and managers make more informed, responsible investment decisions.
The full effect of the COVID-19 pandemic on global markets is still unclear, however there are some early indications that ESG indices have outperformed their peers as highlighted by MSCI (blog) and that ESG funds have not suffered the same outflows (Schroders). Although it is too early to effectively draw a meaningful conclusion, given how society has responded to previous socially and environmentally impactful events, investors and fund managers should expect to continue to see responsible investment becoming the norm.