Hedge fund investors want a new information edge

21st February 2012

But investors in these vehicles, including many UK pension funds, are increasingly restless. Long gone are the days when hedge fund and investment success were synonymous – the easy epoch when short selling was a virtually guaranteed route to riches if for no other reason than traditional funds could only take long positions.

More recently, hedge funds, with their bewildering variety of strategies, have been seen to struggle. So investors are calling for more transparency, according to a new report from SEI, a US firm active in "Innovative solutions for creating and managing wealth, including asset management, investment processing, and investment operations."

Transparency is key

Together with research group Greenwich Associates, it has just published its annual study of the hedge fund world. While institutional investors "continue to deepen their commitment to hedge funds," they now demand more transparency.

The report, entitled "The Shifting Hedge Fund Landscape: Institutions Put Fund Managers to the Test," suggests investors "expect much more from managers in terms of articulating their value proposition, risk mitigation methodology, and performance expectations."  They want managers to explain the trade-offs between risk and reward as well as performance expectations and a clear exposition of strategies to "maintain investor confidence" – a phrase that means attracting new capital at best or preventing existing holders from exiting at worst.

Worst six months since the 2008 crash

In 2011, hedge fund managers had their worst twelve months since the 2008 banking crisis – in the first six months alone (and figures for all of 2011 are still to be added up) those funds on the SEI radar saw average annualised returns of 6.2%, in 2010 it was half as much again at 9.2% – other hedge fund performance figures may differ as no two universes seem to be the same.

It is that lack of transparency over recent performance and strategic direction that disturbs some investors. While mainstream investment funds now produce monthly reports – admittedly with generally simpler portfolios and with a great variance in quality – hedge funds have mostly stuck to six monthly reports, often produced many weeks after the period in question ended.

"Particularly in times of market uncertainty, managers must proactively communicate with investors with the goal of reinforcing confidence in the manager's investment process," says Philip Masterson Senior Vice President and Head of Business Development, Europe, for SEI's Investment Manager Services division. "Investors are clearly looking for better returns, but they are also demanding a higher degree of overall risk management. To stand out and attract investors, managers will have to be more forthcoming not just in how they are enhancing their investors' returns, but also demonstrate how they manage the portfolio's risk exposure."

Hedge fund investors are professionals, who should know how and why they are investing. And the funds and their investors should be able to engage in meaningful and mutually beneficial conversation. Some funds say their returns are lower because investors want them to hedge risk rather than boost returns. Investing institutions, hedge funds told the SEI report, "keep ratcheting up the challenges and requirements they pose".

Ideas for a dialogue

Here are some thoughts – they could apply to retail funds and to more sophisticated investors and advisers as well. 

Demonstrate exactly how strategies and methods are enhancing clients' risk -adjusted portfolio returns. Many fund managers fail to make their methodology clear – it is difficult for investors to chose if all funds carry the same label (such as UK Corporate bonds) without the managers themselves offering further explanation.

Clarify performance expectations so investors understand the fund's objectives, tolerance to risk and the trade-offs between risk and reward. Retail funds need firstly to explain the idea of risk-adjusted figures as all too many marketing promotion merely state the gains over a certain period without any reference to risk, often leading to investor disappointment.  And once investors have understood this point, funds should manage what they expect.

Ensure that strategies are understandable by investors – some UK retail funds have confusing labels such as managed cautious or cautious managed. And there are concerns over absolute return funds.

And with the big changes of the Retail Distribution Review looming up fast, here is the take of Mindful Money blogger Kim Stephenson on the transparency – and fees –  issue.


More from Mindful Money:

Corporate truth: The art of transparency

Is the 'risk on, risk off' investment style on or off?

Is cybercrime good news for investors?

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