Despite these issues, funds of hedge funds manage assets totalling $541bn (€413bn) and control over half of the hedge fund industry, according to InvestHedge.
 According to the Edhec Risk and Asset Management Research Centre, the development of hedge funds has not been attended by a proper consideration of the specific characteristics of the risks and returns of these alternative investments with regard to the provision of information to investors.
 A study carried out by the French-based business school in 2003 found that most European hedge fund managers made do with a reporting method designed for investment in traditional asset classes. This method was deemed to be totally inappropriate because it failed to account for the specific risk factors affecting the different returns of the hedge fund strategies in which funds of funds are invested in.
 Edhec, however, recently published the results of a follow-up survey conducted last year which found that investors and fund managers are progressively adapting their reporting tools to the particular needs of hedge funds.
 The survey found broad consensus among respondents on what they regarded as relevant information. They agreed that funds of hedge funds reports should cover the whole risk spectrum, including volatility, maximum drawdown and extreme risks such as modified value-at-risk. They also felt that investors should be provided with information on the key factors (such as volatility risk, liquidity risk, credit risk) driving fund of hedge fund performance, so they can better understand the fund’s risk profile and as a result integrate it more easily into their global allocation process.
 The survey, which formed a consultation process for the implementation of a new framework for funds of hedge funds reporting, revealed that most of the 98 respondents, representing over $1100bn of assets under management, favoured monthly reports and wanted a report with aggregations at the strategy group, strategy and fund levels.
 Forty-six per cent of fund managers and 74 per cent of investors considered that a style value-at-risk should be disclosed to investors. Thirty-seven per cent of fund managers and 48 per cent of investors favour disclosure of a modified value-at-risk.
 The Sharpe ratio is considered essential by 77 per cent of fund managers and 79 per cent of investors, while the Omega ratio is now required by 57 per cent of fund managers and 48 per cent of investors.
 Where the 2003 study found that 47 per cent of fund managers were integrating a style analysis in their activity reports, the latest survey revealed that 67 per cent of fund managers and 84 per cent of investors now consider that both static and dynamic style analysis should be contained in fund of hedge fund reports.
 For factor analysis, these figures are 56 per cent and 85 per cent respectively. The study shows that 73 per cent of fund managers and 90 per cent of investors would also like to find unconditional and conditional correlations with risk factors.
 Edhec argues that it is possible to satisfy investor demands for information without compromising managers’ desires for secrecy. Indeed, the researchers claim that by following the recommendations contained in the report, fund managers can provide investors with valuable information on their fund performance and risk profile without disclosing detailed positions.
 Jean-Rene Giraud, CEO at the Edhec Risk and Asset Management Centre, said that the level of reporting by funds of hedge funds was generally inconsistent and “can often be frightening”. Worryingly for investors, he said that 30 per cent of funds of hedge funds in Europe do not have a risk management function.
 Mr Giraud said the results were encouraging because they showed that fund of hedge fund managers were starting to take heed of academic recommendations on reporting levels such as those put forward by the business school. He pointed out that a year ago, funds of hedge funds were not inclined to report anything other than volatility and their measure of volatility. So some progress has been made.
 The findings suggest that managers plan to work harder to improve the quality of their reports in order to meet the growing demands of investors. And if such good intentions translate into changes in practice, more investors might be tempted to take the plunge into the murky world of hedge funds.
Henry Smith, editor, henry.smith@ft.com

Printer friendly version