Respectability is critical for the industry’s future

Wed May 25, 2011

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It’s time to think about how hedge funds look from the outside

By Nick Evans

Of all the many diverse and thought-provoking views and ideas that emerged at this month’s packed and compelling EuroHedge Summit in Paris, one in particular lingers in the mind.

That was when Kathryn Graham, investment director at the BT Pension Scheme – the UK’s biggest pension fund and the very epitome of the type of institutional investor that most funds most want to attract in the post-crisis era – said that hedge funds were “not respectable enough” for her to feel comfortable about asking her board of trustees to approve the kind of allocation level to hedge funds that she might otherwise want to see in her portfolios.

That is a very telling, and damning, indictment. And it is a warning that the hedge fund industry must heed – if, as there is every reason to suppose and hope, the industry is successfully to emerge from the financial chaos of the last few years as a beneficiary rather than as a victim.

Graham is no ingenue in the world of hedge fund investing. The £34 billion BT pension scheme is one of the largest European-based direct pension fund investors to hedge funds, as well as through funds of funds, and it also runs its own affiliate fund of funds business as well as advising other institutions on alternative investments and managing portfolios for them.

She is an influential figure in the Hedge Fund Standards Board’s recently launched Investor Chapter. And she is playing a key role in other important new investor-led industry initiatives such as the OPERA plan for providing hedge fund investors with aggregated and standardised risk reporting.

So she fully buys – as no sane investor has any excuse not to do any longer – the idea and the value of investing in hedge funds as a vital part of a well-managed, diversified and properly protected investment portfolio.

But she also knows full well, as a representative of a pension scheme responsible for the savings and livelihoods of many tens of thousands of ordinary individuals, how hedge funds look to the outside world.

And her point is a critical one for the industry’s future. Rightly or wrongly, hedge funds are perceived – not just by the public, which is damaging enough, but by some of their own investors – as cavalier and renegade operations, where managers are given the licence by their lawyers to do pretty much what they want when they want, and as businesses that like to keep communication to a minimum and generally raise two fingers to the world at large.

That is the real reason why regulators, wrongly but perhaps understandably, need to be seen to be taking action to bring hedge funds more overtly into the regulated world; why the hedge fund industry, for all the points it can make quite rightly and potently in its defence, is in danger of losing the wider battle for hearts and minds; and why, for many people, UCITS funds – with their veneer of respectability and regulatory control – are so much in vogue.

One could argue that investors could and should have done more about this long before now. They, of all people, have the power to make hedge fund managers (and their legal advisers) change their ways – not in terms of how managers manage their portfolios, which they broadly do pretty well, but in terms of how they manage and carry on their businesses, which they broadly do a good deal less well.

But it is better late than never. It is high time that hedge funds were run as proper businesses with proper levels of governance, with directors that are not just puppets but people who know what they are doing, and managed by people who understand that good business management is every bit as important as good money management.

Plenty of hedge funds already do this perfectly well. But plenty more do not. At a time when the Galleon insider trading conviction has the potential to deal the industry another very serious blow in terms of reputation – and is being seized on by those who wish the industry ill as evidence that they are right to be sceptical and suspicious – there is no time to waste.

It is time to wise up, ignore the often ill-conceived and harmful advice of expensive legal counsel, listen to investors, think about how hedge funds look from the outside and present a face that is far more accommodating, politically savvy, self-aware and plain respectable.

Being a smart portfolio manager is not enough on its own anymore. Being a smart business manager is what will determine success or failure in this new, more institutional and far more public world.

ISSN: 2151-1845 / CDC10004H

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