Morningstar hedge fund data could create new challenges

Date: Monday, November 27, 2006
Author: Jeff Benjamin, InvestmentNews.com

DETROIT - Morningstar Inc., making good on a three-year-old commitment to help better define a heretofore opaque hedge fund industry, is within weeks of rolling out what will be among the most comprehensive hedge fund research databases.

Its universe of more than 6,000 hedge funds includes a majority of the estimated 10,000 hedge funds worldwide.

Unlike many hedge fund databases, which might track several hundred hedge funds for asset allocation purposes or to construct investible indexes, Chicago-based Morningstar's intentions are said to be purely research based.

In essence, although Morningstar isn't expected to start offering investment products, it does include access to its hedge fund data in many of the paid-subscriber services it sells to institutional investors, advisers and individual investors.

But even that raises some questions among financial advisers concerned that the company which made mutual fund data so accessible could be providing too much information with regard to hedge funds.

Public beware

"I worry about making complex investment information available to the public," said Clinton Struthers, president of Struthers Financial Services in Midland, Mich.

Mr. Struthers, who called his a "love-hate relationship with Morningstar" because of the company's wide-open research distribution policies, said that making even limited hedge fund information available to individual investors will only make an adviser's job more difficult.

"As financial advisers, we have a responsibility to know what we're talking about, and Morningstar's hedge fund information is something we're looking forward to," he said. "But they also make the information available to Joe Public, and more often than not, Joe Public is misinterpreting the information and ends up getting hurt."

After spending almost three years building a database the old-fashioned way - by identifying and soliciting participation from thousands of individual hedge fund managers - Morningstar paid $10 million in August for Wayne, Pa.-based InvestorForce Inc. The move essentially doubled the size of Morningstar's hedge fund database.

In addition to some research tools and a database of 2,000 separately managed account money managers, the InvestorForce deal netted Morningstar an active database of about 3,500 hedge funds.

Merging the acquired data with the 3,500 hedge funds in Morningstar's homegrown database while factoring in overlap is expected to produce an active universe of about 6,000 hedge funds, according to Ryan Tagal, product manager in charge of the database.

After having spent the past few months coordinating the consolidation of the respective databases, he said that Morningstar remains focused on developing the ultimate hedge fund database.

"We're still growing our database, and we've identified literally thousands of hedge funds that we'd like to invite to our database," Mr. Tagal said. "It's really our mission to track all investments."

Part of that mission eventually could include in-depth analysis and a ranking system for hedge funds, comparable to the firm's well-

recognized star ratings for mutual funds.

The upcoming launch of the expanded database pushes Morningstar ahead of Denver-based Lipper Inc., which tracks more than 4,000 hedge funds.

Lipper acquired the bulk of its database in a private deal last year with Tremont Capital Management Inc. of Rye, N.Y.

Like Morningstar, Lipper uses its database primarily to provide subscribers with a resource for analyzing the $1.3 trillion hedge fund industry.

Morningstar's leap ahead of Lipper received just a shrug from Ferenc Sanderson, the Cleveland-based Lipper senior research analyst in charge of the database.

"More names might offer a better idea of statistical performance," he said. "Some people might look at a database and automatically say more funds are better, but it still comes down to the quality of the data."

When it comes to hedge funds - private investment partnerships that aren't required to report to any database - the quality of the information always is suspect, said Thomas Orecchio, principal at Greenbaum & Orecchio Inc. of Old Tappan, N.J.

"Morningstar has done a very good job with mutual funds, and I'm assuming they'll go after hedge funds with the same vengeance, and they might eventually become the industry standard for tracking hedge funds," he said. "But the bad news is, hedge fund industry data is as dirty as it gets because of the voluntary nature of the reporting, and that means garbage in, garbage out."

Without additional regulatory oversight of the hedge fund industry, it is unlikely that any database could ever be considered complete, according to John Van, chief financial officer of Greenwich-Van LLC. The Nashville, Tenn.-based firm operates an investible index and allocates client assets to hedge funds.

Missing in action

Hedge funds often report to databases for marketing purposes, Mr. Van said, and funds that no longer seek new investors or that might have poor performance are more likely to avoid reporting to databases.

"There are always bragging rights for having a bigger whatever it is," he added. "With hedge funds, the more managers you have, the more representative you are of the overall universe."

The basic idea of greater access to information is enough to entice Tom Norris, president of NFI Advisors Inc. in Southfield, Mich.

"The more knowledge or information you can gather, the more likely it is to position a client's portfolio to garner a portion of that return," he said. "Hedge funds are home run hitters, and I like to hit singles and doubles, but if you're following what they're doing, you can tone it back and hopefully get a portion of their returns."

Access to Morningstar's hedge fund database is restricted to wealthy investors, institutions and financial intermediaries through subscription options ranging from $135 annually for a basic snapshot profile to $15,000 annually for a fully comprehensive breakdown of the database.