Fitch Releases First Hedge Fund/Fund Of Funds Report

by Carla Johnson, Investors Offshore.com

10 September 2001

The Fitch International rating agency has published its first ever report evaluating hedge funds and funds of funds. The agency undertook the report in response to the significantly increasing number of requests it has received to rate hedge funds and related fund-of-funds structures.

According to a statement released by Fitch last week, the report's primary focus is on structured products as a 'growing application for hedge funds' and addresses counterparty analysis and secured debt. The report, entitled 'Hedge Funds: A New Asset Class in Structured Finance', highlights some of the unique challenges related to hedge funds/funds of funds and structured securities.

Some of the issues and attendant risks include:

• Loose definitions of investment strategies, which make it difficult to set sufficient parameters
• Manager-specific risk issues, such as investment 'style drift' and key-man risk
• Use of leverage, including off-balance sheet derivatives
• Liquidity management
• Quantifying overcollateralization/credit enhancement levels

In summing up some of its findings, Fitch considers that some hedge fund managers will be able to leverage their underlying investment portfolios to access the capital markets in the form of rated debt. However, given the potential for dramatic losses and the industry's unregulated nature and relative lack of transparency, Fitch believes that these structures warrant an extra measure of caution and due diligence.

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