Major improvements in hedge fund transparency, according to Preqin poll

Date: Monday, June 13, 2011
Author: Charles Gubert, COO Connect

Hedge fund transparency has markedly improved over the last year, according to a Preqin poll of institutional investors.

Some 96% of investors surveyed said there had been an improvement in the level of hedge fund transparency compared with just 42% in 2010. No single investor claimed there had been a decline in transparency. Furthermore, it revealed that 84% of institutional investors would reject funds that did not meet their transparency requirements. Funds of hedge funds were particularly vocal on this issue given the high-profile links some of these vehicles had to Bernard Madoff and other frauds, as well as the lacklustre performances many endured during 2008.

“The hedge fund industry has reacted quickly to changing investor sentiment rebounding from the financial crisis by responding readily to requests to improve back office operations and making many internal procedures more transparent. Managers have recognised that in order to gain institutional backing in the post-crisis, post-Madoff environment, a higher degree of openness must be embraced as part of hedge fund culture and the era of ‘black box’ funds must come to an end,” read the report.

Since the market crisis, 78% of investors acknowledged they had upped the ante on their operational due diligence on their hedge funds while 22% said their monitoring procedures remained unchanged. Approximately two thirds of investors expect to see a breakdown of their underlying hedge funds by sectors to help identify what they are exposed to. Some 60% of investors demand information showing profit and loss attribution. A further 54% want information on the top five holdings of their hedge funds by name – all of these are available on monthly performance update sheets or initial offering documents.

Regular performance updates are essential to appease investors with 71% requiring their managers to disclose performance on a monthly basis. A large minority of 37% expect weekly performance updates. Only 4% said quarterly performance updates were acceptable.

Full position transparency is also of major importance to 54% of investors while 24% request real-time access to this information. However, the majority of investors were satisfied with time lagged data. Nevertheless, “there could be potential for a mismatch between investor demands and manager disclosure on this point as many managers do not and will not offer this full portfolio disclosure information due to the commercial risks of doing so,” said the report.

Significant numbers of investors also want the hedge funds’ risk profiles and management to be readily available. Such information would include regular Value-at-Risk (VAR) updates and counterparty exposure.

“In this era of heightened demand for liquidity from hedge fund investments and following the gating of assets and exposure to hitherto unknown illiquid assets back in 2008, it is unsurprising that more than half of all the investors in the study noted that they demand a breakdown of the liquidity in their funds,” it added.

The report warned that institutional investors will simply not allocate capital to hedge funds that failed to meet basic transparency criteria. Therefore, “it is likely that levels of disclosure will increase in the future with transparent business practices becoming a standardised and expected element of the hedge fund industry. If hedge funds do not respond to institutional pressure for increased transparency, they not only face difficulties in gaining fresh investment but are also likely to experience large outflows as investors seek to place their capital with managers that will offer them the transparency which is deemed so important,” concluded Preqin.