Investment consultant Albourne Partners, the world’s largest hedge fund advisory firm, has told the U.K. Hedge Fund Working Group (HFWG) to tighten up its proposed Hedge Fund Code by including more specific recommendations. The proposed code, published last October by HFWG is based on input from 14 leading hedge funds; the final report is expected later this month.
Responding to the HFWG proposals, Albourne Partners said that the HFWG guidelines need “to go further" in order to mitigate the risks faced by institutional investors when investing in “unregulated structures” and that one major source of frustration for investors is the “almost universal absence of specifics in investment objectives.”
One of Albourne’s major concerns is that the HFWG did not include any representation from investors. Its response to the proposals includes comments from several of its clients, including the Australian Reward Investment Alliance (ARIA), Caisse de Dépot et Placement du Québec, Fleming Family & Partners and Hermes.
Albourne is calling for more specific rules in a number of areas including hedge fund disclosure, valuation, risk reporting and fund governance. Its specific recommendations include:
Disclosure to Investors and Counterparties:
- The HFWG should prescribe a minimum standard of content for a hedge fund offering memorandum. The memorandum should describe specifically the activities of the fund and should not use boilerplate language. Investors should be told at least the following: volatility objective, correlation objective, return objective, whether these objectives have changed, the history of the fund, and the manager’s specific objectives.
- Certain practices should be noted as not “best practice,” for example, redemption terms that can be waived, material changes to investment objectives without prior written notice, absence of requirement for shareholder votes on any material changes to the fund and redemption fees/penalties payable to the manager (not the fund).
- There should be clear explanation of both the fees and expenses that will be charged highlighting the gross returns required for net returns to be achieved.
- All investors should receive the same frequency of communications. There should be a minimum standard of notification to investors. Notification should include legal claims against the fund; changes to service providers; key departures; changes to the offering memorandum, investment objective, investment management agreement, articles of association; if and when conflicts occur; any significant reduction or increase in assets under management; any significant reduction in the principal’s investment in the fund.
Valuation:
- Best practice should be that a third-party administrator is responsible for valuing the fund’s portfolio and calculating the management and performance fees payable to the manager–independently of the management company (According to Albourne, investors support this view even though the cost of administrators is borne by the fund and thus themselves.)
- The industry should adopt standard valuation guidelines – the Alternative Investment Management Association (AIMA) guidelines should be adopted as best practice.
Risk reporting:
- Hedge fund managers should provide information in a consistent format that will enable investors to evaluate, compare and monitor risk of their investment. There needs to be a requirement for consistent and standard definitions of leverage that are universally applied.
Fund governance:
- Currently, the governing body / board of directors offers little protection to investors. There should be a majority of non-executive directors on the board, directors should have the experience and capabilities to understand the strategy and risks of the fund, and directors should actually meet as a board (i.e., face-to-face) on a quarterly basis.
To view the HFWG proposals, click on: Hedge Fund Standards: Part 1, Executive Summary or Hedge Fund Standards: Part 2, Best Practice Standards.