Hedge fund investors are permitted to withdraw funds at any time in response to poor fund performance or governance, although if they have not had the funds invested for a certain amount of time, they may be charged a fee for early withdrawal. And, not surprisingly, hedge fund investors have long desired higher quality governance for several reasons, such as the financial crisis of 2008 and the Bernie Madoff scandal.
A study from PriceWaterhouseCoopers found that an estimated 89% of hedge funds make at least monthly disclosures to investors. This aligns with Shadab’s argument that hedge fund managers are not ripping people off because the governance structure makes it difficult to do so.
There are also mechanisms that funds can include in their fee structure to help investors, such as a high-water mark, which is a section of the governance piece that limits managers from profiting from a performance fee until the account regains losses from previous years.
There is also the hurdle rate, which prohibits fund managers from being paid unless a minimum rate of return is achieved. Shadab also believes that if managers invest personally in the fund, they will likely make wise choices because they have a personal stake. However, co-investment may also cause the fund manager to be too cautious when brokering deals.
Shadab raises an interesting point about hedge fund transparency in this article. He suggests that, “investors are often better off with less disclosure, higher fees, and less access to their capital.” As could be expected, this is not a popular sentiment among investors.
However, Shadab believes that, “complete transparency into a fund‘s specific investment positions may be overwhelming and not provide a basis for investors to make a meaningful comparison between managers.” He also points out that too many disclosures could lead to another trader gaining access to fund information, which will damage the fund’s competitive advantage and ability to provide investors with consistent returns.
On the other hand, Halah Touryalai argues that clear reporting leads to increased operational efficiency and allows investors to focus on what works. Making evidence-based decisions allows everyone involved to strengthen the fund and working relationships. She also says there are software options that allow for targeted transparency so you can pick and choose what data is revealed to whom.
However, Shadab believes that the hedge fund industry has shifted (and continues to) toward more voluntary transparency in an effort to appease investors who are concerned they do not know enough about where their money is being invested.
While the ideal level of transparency and the effectiveness of governance are currently being debated, legislators try various methods to help investors. Primarily, the SEC restricts hedge funds’ ability to advertise and potential group of investors. Currently (this may change with the JOBS Act), hedge funds cannot advertise themselves to the general public. In addition, only accredited investors are allowed to invest in hedge funds, since the government deems them wealthy enough to understand the risk involved.
However, if you’re interested in knowing how hedge funds have historically invested, you can read their 13F filings. Though they only list qualifying securities, you can fairly closely watch the investments of long funds (and NYSE Euronext) has just petitioned the SEC to reduce the 13F filing period to 2 days).
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