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Report Draws Attention To 'Stale' Pricing Issues For Hedge Funds

by Philip Morton, Investors

19 December 2003

As the investigative spotlight in the United States focuses in on market timing and late trading practices permitted by some mutual funds, a report published by the Wall Street Journal this week has pointed to potential timing-related pricing problems within the hedge fund industry itself.

According to the WSJ, the majority of hedge funds report on their performance once a month, but because many invest in illiquid securities, it can take more than a month to calculate and verify the relevant figures.

This can be something of an issue for hedge funds investing in other hedge funds, which are obliged to wait until each underlying fund has reported its results.

Although, as purchases and redemptions are only usually permitted a few times a year, this reporting lag is unlikely to inconvenience investors. Virginia Parker, president of Parker Global Strategies explained to the business daily that many large investors insist that hedge fund managers impose a cut-off date.

This means that if the managers of the underlying funds have not reported their returns by a certain date, the fund of hedge funds will be obliged to calculate its performance based on the previous month's values.

The WSJ explained that:

"This can work to the advantage or disadvantage of investors buying in or cashing out that month. If the late-reporting managers had a good month, incoming investors buying shares based on the previous month's prices will be getting a bargain, while outgoing investors are shortchanged. Likewise, if the late reporting manager has had a bad month, incoming fund-of-hedge fund investors may be paying too much for their shares, while outgoing fund-of-hedge fund investors will escape the impact of the underlying manager's losses."

Although Ms Parker announced that she was not yet aware of any investors seeking to trade rapidly in and out of funds of hedge funds in order to exploit stale pricing situations, she suggested that the potential for abuse was certainly there, and was likely to become of interest as the investigation into unfair trading practices expands.

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