Hedge Fund Transparency May Be Phyrric Victory For Institutions

by Carla Johnson, Investors Offshore, London

07 March 2003

It is beginning to look as if transparency may be the battleground on which the future of hedge funds is fought out. Traditionally, hedge funds are secretive about their detailed trading strategies and positions, partly on competitive grounds and partly because public knowledge of a position can weaken it in market terms. The funds have been able to avoid disclosure because they market to experienced investors who are not 'protected' by zealous regulators anxious to shine a bright light on every smallest aspect of an investible asset.

The development of the hedge fund universe in the last five years has however been strongly in the direction of smaller, retail investors, through the emergence of hedge funds of funds, the systematic lowering of investment minimums to encourage less affluent investors to take part, and the arrival of the politically-correct institutions at the hedge market feeding trough. Not surprisingly, this has attracted the attention of the regulators, and many funds are hastening to disclose more about their activities.

Still, old habits die hard, and it is no surprise this week to hear Mark Weller, head of hedge fund sales at London-based risk management consultancy Reech Capital saying that fund of funds are failing to obtain full information on a third of their underlying managers. "If fund of funds want to attract institutional money, they have to be more forthcoming," he said. "But their biggest problem is to get access to some of the underlying trading positions."

Reech's RiskHedge product is used by hedge funds to help them monitor closely the risk position of their funds and in turn provide assurance on this position to their investors. Reech Capital launched RiskHedge at the beginning of 2002. Risk-Hedge is capable of handling a wide range of asset classes and trade structures as well as offering reporting customisation. It allows strategy and exposure (including gross long, short, stress and sensitivity), value at risk, strategy, country and sector risk and performance attribution, all to be monitored.

UBS's fund of fund specialist GAM uses RiskHedge to administer the supervision of individual hedge funds, but admits that it would, in certain cases, continue to invest in funds that do not provide full disclosure. "Every manager we are exposed to gives us a level of transparency that we are comfortable with," said David Smith, chief investment director at GAM's hedge fund business, to the Financial Times. GAM provides investors with a weekly report on the aggregate exposure of their top-ten funds held in its portfolios. But Mr Smith said extensive monitoring could lull investors into a "false sense of security".

Iain Jenkins, managing director of EuroHedge, a newsletter and research group, warns that there is a conflict between disclosure and returns in the case of hedge funds. "Institutional investors are facing a trade-off," he said. "The more they go down the risk control process, the more they run the risk of lower returns."

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