Separately Managed Accounts (SMAs) have gained increasing prevalence in recent years and has become a popular choice amongst major institutional investors in North America and the Middle East including but not limited to pension funds and sovereign funds. It is expected that new SMA launches will experience significant growth in 2026 and is projected to reach US$5.1 trillion in 2026 (see projection by FUSE Research Network).
From a fund manager or general partner perspective, SMAs can offer a significant source of growth for fund managers in Hong Kong to expand their assets under management, which may invest typically alongside a master fund or other fund offerings as we see foreign capital returning to the Greater China market.
The Drive for SMAs
Endorsed by many private banks and wealth management platforms, SMAs provide a combination of flexibility, control and customisation well suited for institutional investors, such as pension funds, insurance companies, family offices and high-net-worth individuals, whilst allowing the investor to maintain direct ownership of assets. Typically an SMA arrangement would involve a vehicle of one held by the investor with a platform manager to handle operational matters such as monitoring of accounts, rebalancing the portfolio, treasury and managing investor requests for withdrawals and deposits. This allows the vehicle to appoint a number of different portfolio managers to manage different pockets of capital allocations in the vehicle.
Compared with a commingled hedge fund, the investor of an SMA would be able to maintain oversight and greater control over its assets with tailored investment strategies and restrictions. The investor can also choose its preferred service providers including the platform manager, the administrator, auditors and brokers. One important aspect of SMAs is the use of notional funding and cross-margin arrangements, which enables the investor to minimise idle collateral, maximise cash usage and manage financing costs as between its different pockets of allocation. Investors also have real-time visibility into their portfolios and the ability to monitor trade activity and counterparty risk exposures in real-time. This helps investors to quantify its risk exposure and react to market changes and macroeconomic shocks quickly to protect its investments, particularly in light of today’s complex geopolitical environment.
From a portfolio manager’s perspective, SMAs can enable portfolio managers to focus greater on generating returns and meeting investment targets whilst leaving operational, legal and compliance matters with the platform manager.
The Importance of Negotiating SMAs
SMAs are expected to stay and continue to shift investor / LP-GP dynamics. It is therefore critical that portfolio managers understand and are well informed of the legal implication of certain terms contained in a proposed SMA and is able to consider the operational feasibility of such arrangement before entering into an agreement.
Most Favoured Nation (MFN)
SMA negotiations will typically involve an investor’s request for a MFN provision whereby they must be offered the same or preferred terms as opposed to any other clients of the portfolio manager investing the same or a lesser amount of capital than that committed in the SMA. MFNs are typically drafted broadly and portfolio managers need to be aware that by accepting such terms, it may restrict its ability to negotiate investment terms and fee arrangements with future clients (and potentially new investors of its other fund offerings).
Limitations on discretionary powers
With investors seeking greater control over its portfolio, SMAs may contain terms which restrict the portfolio manager’s powers and may require portfolio managers to follow investor instructions on trading in certain situations. Hong Kong licensed portfolio managers would need to be clearly advised on licensing and regulatory implications to avoid breaching local securities laws and negotiation of terms to balance reserve powers of the portfolio manager would be crucial.
Withdrawals and terminations
Given the time and effort involved in setting up the SMA, portfolio managers will need to carefully consider withdrawal and redemption arrangements as well as termination triggers which are typically embedded in contractual terms. SMAs will typically reserve powers to the investor to withdraw capital with no or little prior notice to manage cross-margin arrangements and short windows for termination.
Operational challenges
Due to their bespoke nature, SMAs will typically create a number of operational challenges. For example, SMAs will typically require trading of securities on a pari passu basis with the portfolio manager’s other clients and/or fund offerings, which raises difficulties where different brokers are used and where the SMA contractually restricts the portfolio manager’s powers in selecting and appointing brokers. SMAs will also commonly require real-time daily reporting of trades within certain time zones and may require the portfolio manager to provide certain tax and reporting obligations. Portfolio managers would need to carefully consider the feasibility of such requests.
Fee calculations
Due to high levels of customisation, we typically see a variety of performance fee and management fee calculation methodologies across SMAs compared to a more standard high-on-high calculation standard for comingled hedge funds. Portfolio managers will need to clearly understand its remuneration basis (and any exclusions in such formula) and how certain events may impact the calculation of fees, such as partial withdrawals. Typically fee arrangements and items to include or exclude from calculation will require certain degrees of negotiation and specification.
Other bespoke terms
Other than the above typical matters, investors may ask for bespoke terms and overarching reserve powers. Portfolio managers will need to closely consider how such mandates may impact its ability to take on new clients for its business and to maintain autonomy over its internal matters. It is also crucial to ensure that portfolio managers are not providing representations and warranties that are unduly burdensome or commercially unsound.
At Deacons, we have vast experience in advising and negotiating on behalf of our clients SMA contracts and are familiar with the typical pitfalls portfolio managers face when operating such contracts in practice. Please reach out to our team for further information and advice and to discuss how we may assist.
