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Innovative ideas and services for the
hedge fund industry
Transparency
Transparency is a major concern for
institutional investors. Yet many hedge fund firms are reluctant to provide
full transparency despite institutional investor concerns for the following
reasons:
- Logistics and expense – many hedge
fund managers believe that providing full transparency is a big commitment
especially if they are frequent traders. This commitment consumes valuable
staff time and resources.
- Reluctance to reveal proprietary
strategies – hedge fund managers are often reluctant to reveal proprietary
strategies for fear they may expose their investment strategy to competitors
(and those clients who may be tempted to do it themselves).
- Vulnerability of positions –
revealing proprietary strategies and specific security positions could render
these securities vulnerable as they would be an open position.
- Wasted effort – many hedge fund
managers are reluctant to commit significant time and resources as they
question whether the information will ultimately be useful and beneficial to
users. Consequently, they may not wish to compile this information and commit
to ongoing preparation if the ultimate benefit and pay back cannot be
established.
We offer consulting services and
attestation services to facilitate a fund manager’s commitment to transparency.
Services include attestation that a manager has complied with investment mandate
or the disclosed investment criteria. This type of third party attestation can
provide valuable assurance to institutional and private client investors while
leaving many of the proprietary investment manager strategies confidential.
Monitoring services for fund of
funds managers
We offer services that assist hedge
fund of funds managers in monitoring hedge fund sub advisers. Monitoring
covers the following aspects:
- Business monitoring – evaluating the
organization itself. We look beyond the investment management component and
review and evaluate aspects such as the team and organization’s
infrastructure; we evaluate the ethics, reputation and conduct an assessment
of the operational risks.
- Fund monitoring – this involves a
review of the client investor profile and how the firm markets to investors.
Analysis here includes a review to determine whether everyone invested in the
fund gets the same treatment in terms of fees and liquidity; do liquidity
parameters change as the fund increases in assets under management?
- Investment monitoring – here we look
at how the investment manager is actually reviewing the portfolio and
monitoring such aspects as currency and sector exposure as well as other
important elements. Is the underlying portfolio in accordance with the stated
investment guidelines criteria and mandate?
- Operational monitoring – What is the
quality of the back office, operational and accounting structure? Some hedge
funds have incurred significant losses and have had extremely poor investment
results due in large part to operational weaknesses.
We can develop programs for fund of
funds managers to monitor hedge fund firms. It is often more efficient for
the fund of funds managers to outsource this type of work rather then
perform internally and incur significant travel costs. It is also cost effective
for hedge fund firms to engage our services and provide our reports and
assurances to various fund of funds managers.
Lifecycle stages and Operational due
diligence
A rule of thumb that has developed among
investors is to invest in those hedge funds that are in the relative early days
of their life cycle. Studies have shown (Donald Sussman - CFA Institute 2004
conference proceedings) that the “sweet spot” of the hedge fund lifecycle is
found early on in the hedge fund’s career when assets under management are in
the small to medium range.
We assist hedge fund and fund of
funds managers in dealing with the operational infrastructure and internal
control environment. Small funds are generally small operations where
operational infrastructure has been either outsourced or is nonexistent. We
assess both the hedge fund and fund of funds manager to assess
operational risks and improve operational controls.
Regardless of the different sizes and
level of resources within the hedge fund operations at minimum there has to be a
consistent and effective integration of the following elements:
·
Decision support
·
Trade execution
·
Risk management
·
Compliance
·
Accounting systems
We assist managers in improving internal
controls that begin at the trading desk and end at the accounting and operations
area. We can provide support services covering operational due diligence to
fund of funds managers, hedge fund managers, as well as institutional
investors.
Regulatory concerns over hedge funds
The SEC has cited three concerns about
hedge funds: fraud, retailization, and conflicts of interest. Specifically:
- Fraud – is the manager making
misrepresentations? Is there style drift? Is the manager taking extraordinary
risks that are inconsistent with the stated investment objectives and mandate?
- Retailization- hedge funds are being
marketed to a broader array of investors including those that may not be
considered accredited or sophisticated. Does the manager have adequate
safeguards in their marketing process to ensure suitability?
- Conflicts of interests – there are
many instances of the potential for using hedge funds as a mechanism for
getting around personal trading rules and best execution rules. We can help
identify both real and perceived conflicts.
In December, 2003 the SEC released
IC-26299 entitled Compliance Program of Investment Companies and Investment
Advisors. Some of the major issues in this release include the following:
- Compliance policy and program. Does
the program address the following:
- Application of investment
opportunities
- Trading practices
- Adequacy and accuracy of disclosure
- Records
- Marketing advisory services
- Process of valuing client holdings
and assessing fees
- Business continuity plans
- Annual review of compliance policy
- Appointment of chief compliance
officer
- Best practices – does the firm have
effective introspection, and self reflection? Does the firm review trading and
compliance procedures in light of the SEC’s hedge fund industry report
- Does the firm adhere to best
practices for solicitation? The following are considered important areas in
the marketing of hedge funds and evaluating solicitations:
- Rational basis
- Sophistication
- Preexisting relationship
- Time
- Nature and quality of information
- Number of offerees
- Investor questionnaire
We work with hedge fund firms to develop
effective and efficient compliance programs and practices that deal with the
above regulatory concerns. We assist firms in developing programs for
“permissible advertising” and “impermissible advertising”. These policies and
procedures can prevent major problems with the regulators down the road.
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