Hedge fund managers are nervous that their complex investment strategies might fall into the wrong hands and have long shrouded their holdings in secrecy. But increased competition to attract funds, and the greater demands and expectations of institutions looking to buy into this space, may slowly begin to shift attitudes.
“In global terms, lack of transparency is still very much a concern for investors,” says Karan Sampson, director of hedge funds at Greenwich Associates. “Hedge funds are somewhat more open to transparency as they morph into the traditional asset management role, but while they may have become accustomed to more detailed questioning, and to be more open with existing clients, generally. I’d say, it’s a question of ‘You can push but you can’t push that far’.”
Increased transparency is also a function of the market’s liquidity, which is making it harder for fund of funds managers to allocate to top managers and forcing them to put more with small players. To win that business, a young company often has to be prepared to release holding information.
“Most managers that have grown to a certain size don’t want to risk performance for cash,” explains Adam Sussman, senior analyst at research and advisory firm TABB Group. “Hedge funds that want to raise additional capital will be more open. For example, a young start-up hedge fund could disclose holdings on a weekly basis to a fund of fund, whereas a more mature fund may only release information on a monthly basis. However, the ultimate goal is to limit the amount of money a hedge fund must take in from fund of funds which not only have greater disclosure requirements (in order to make sure their fund is not overexposed to certain kinds of sectors, stocks, securities, etc) but also tend to pull money in and out of hedge funds more rapidly.”
“Greater disclosure requirements are also required by corporate and public pension plans because of the fiduciary obligations of Erisa in the US. However, pension plans tend to leave their money in a fund for much longer periods of time so the disclosure carries less risk, meaning no one is going to walk away with an idea,” he adds.
“With much larger tickets being written, funds are being as transparent as they can without damaging their strategy,” agrees Melanie Hill, managing partner at quant specialist Sabre Fund. “It’s a very fine line, a balancing act, between giving information to the competition and giving investors sufficient information to ensure they’re comfortable.” This is particularly true of quant, she argues.
Winning comfort
“It is harder for boutique managers to win the comfort of large institutions unless they are prepared to be fairly open – not telling people how the model works, but providing enough information at the top level that they can have a good idea of what markets they perform well in. It’s good business sense, because no-one wants a sudden drawdown after a client has just invested.”
Non-disclosure agreements are sometimes issued for big tickets of over $25m (€19m) if a conversation becomes technical, adds Ms Hill, citing a recent lunch where the prospective investor had himself been a proprietary trader for a bank.
Certain data is highly sensitive, such as any short positions, which have unlimited downside if an informed player knows of the position and trades against the fund. But even asking questions about a third party can reveal that a fund is likely to be a seller.
A lot depends on the individual relationship. “For clients a manager has a good relationship with, there’s no reason a manager can’t provide full positional transparency,” says Aaron Schindler of Schindler Trading in Wisconsin. “I have clients I trust with full transparency. But, in general, there are just too many risks of being traded against or front-runned or short-squeezed for full transparency to become the standard.”
“We’ve been hearing about transparency for many years and when you compare it to 20 years ago, the market has changed completely, but has it really increased in the last 12 months?” said one manager in a big prime broker. “A good manager will never feel comfortable giving full transparency, and I’m not sure it helps. What they have to be better at demonstrating is risk management. I’ve heard investors have asked for daily NAV [net asset valuation calculation], but there is nothing an investor can do with the information.”
Full disclosure is of no value to an investor who does not understand the data himself, and suffers because his fund’s competitors use the leaks.
“Investors often say they want greater transparency but giving them position-level transparency will never be a substitute for a good discussion with the manager about his strategy,” agrees Donald Pepper, managing director, global markets financing and services at Merrill Lynch.
“There is lots of evidence that hedge fund managers get to hear their competitors’ positions, and some hedge funds argue that investors need saving from themselves, because the knowledge would be used against them,” adds Mr Pepper. “Investors should be careful what they wish for.”
One manager even said that he can guarantee to be in receipt of his rivals’ monthly newsletters within 24 hours of their publication.
The raft of management groups seeking a stock market listing has assisted in de-mystifying the industry, but has little impact on position-level disclosure. Recent issues include Fortress, Polar Capital and fixed income credit specialists BlueBay and Ashmore, although some firms such as RAB Capital and Absolute Capital Management have been listed for years. A hedge fund called H20, a fitting pun on liquidity, has just been formed to focus on alternative investment management companies that are public.
