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Tool that helps to benchmark funds


Date: Monday, February 11, 2008
Author: Phil Davis, FT.com

Investing in hedge funds is a time-consuming activity. It is a taxing enough task to assess the strategy and performance of a single fund, without having to compare a raft of similar funds and come to a sensible conclusion about their relative merits.

It is just possible, though, that the tide of useful information may be turning in the favour of investor.

Institutional investors have been able to compare and contrast traditional funds for years following the introduction of Global Investment Performance Standards (Gips), and this tool is now starting to infiltrate the alternatives space.

Gips, a product of self-regulation rather than externally imposed standards, are employed by the majority of large fund managers in developed economies. They demand that managers provide a standardised presentation of fund performance so they can be compared with rival offerings.

Funds must, for instance, provide a strict calendar year track record and show the average of all funds within a strategy, not just the best performing ones.

They should reveal the dispersion compared with the average return as well as the benchmark used and the benchmark's performance over the same time period.

Anthony Howland, founder of Performa , a company that implements Gips systems for fund management firms, says Gips were conceived in the late 1990s to help allay fears that the fund management industry was becoming too powerful and offering insufficient transparency.

"The idea was to stop marketing people labelling every fund 'top quartile'," says Mr Howland.

"The ethos is to provide a level playing field and protect the end investor."

The Chartered Financial Analysts' Institute launched Gips in 1999 and still administers the voluntary scheme. Although there is no official regulator, the US Securities and Exchange Commission enforces them rigorously.

"These days if you incorrectly claim to be Gips compliant, the SEC is likely to be on your back," says Mr Howland, who is also a member of the Gips Committee that administers the standards in the UK.

"We are pushing for the FSA [Financial Services Authority] to take the same stance and are meeting in March to discuss it."

As hedge funds move into the investing mainstream, pressure is building on them to adopt Gips too. At the end of last year, for instance, a consultation document from the UK's Hedge Fund Working Party called for greater transparency and singled out Gips as one way that funds could achieve best practice.

US investors have demanded Gips compliance of their hedge funds for many years. Mr Howland says: "In the US, it is a de-facto standard. You have to be compliant if you want to win business."

But in Europe, with the exception of Switzerland, where some progress has been made, take-up of Gips has been low. Man Group's RMF is one of the early adopters, as is Dalton Strategic Partnership, but elsewhere interest has been limited.

There is reason to believe interest will increase though. In a survey last year, conducted by Charterhouse Research, respondents believed hedge funds would increasingly become compliant in order to sell their funds into the US market and also to meet stricter requirements from European institutional investors.

In fact, four out of five hedge funds surveyed believed they would be compliant within a year.

For their part, investors are demanding a better view of how performance is measured, including the leverage used in funds and other relevant risk data. Mr Howland says: "They increasingly want to know what they are getting into, what is the downside."

He says measures that encourage proper performance calculation avoid situations such as one (unnamed) hedge fund that reported just 35 months of a three-year track record, omitting what it claimed was "an irrelevant outlier month".

Yet many hedge funds have not heard of Gips and are unwilling to invest the time to learn about them. Others have argued the standards do not apply to them because their strategies are too complex or they do not invest using a benchmark.

Mr Howland is dismissive of these arguments. "If you don't have a benchmark, Gips allow you to explain why not. But in reality, everyone has a benchmark, whether it is zero, cash or inflation-plus.

"There is no type of strategy, even quant strategies, that Gips are not capable of being applied to."

Yet the bottom line is that many hedge funds do not have the resources - or believe they do not have the resources - to address the issue. The answer, says Performa, is education.

In the UK, for instance, Mr Howland believes the National Association of Pension Funds is playing an important part in advising trustees on performance reporting standards.

And, on the other side of the divide, representative bodies for alternative investments can apply direct pressure. It would appear to be in investors' interests to understand and be able to address performance-related issues. The Gips organisation, a global body, regularly produces reports and white papers that tackle some of the difficulties investors face. It is currently putting together a paper on risk and is also assessing how to respond to the problems thrown up by the subprime credit crisis.

Mr Howland says: "Gips are not a box-ticking exercise. They really help investors make choices and can protect them. If you take a look at any of the recent blow-ups in hedge funds, not one of those funds has been Gips-compliant."