May 1st, 2013
It’s springtime, when institutional investors are focused on proxy season and news from annual shareholder meetings is publicly reported. We are still awaiting the outcome of some very important contests. (For example, the JPMorgan Chase (NYSE: JPM) annual meeting will be held on May 21 in Tampa. A key item on that agenda is the shareholder proposal to split the CEO and Chairman role at the company.)
For many institutions, proxy season is just one aspect of corporate governance activity that quietly happens all year long.
I expect that US hedge fund investors will soon begin to focus more attention on hedge fund governance. Hedge fund structures now comprise, on average, 10-20% of institutional portfolio holdings. Hedge funds often hold some of the portfolio’s riskiest assets. Despite these facts, hedge fund governance is only now entering into the mainstream consciousness of US institutional investors.
A very informative report was released earlier this year by Jonathan Morgan at Sound Fund Advisors LLC. The title of the free report is “Fund Governance Redux: 2012 Industry Data, Hot Topics & Recommended Best Practices”. I highly recommend this report to all institutional hedge fund investors.
US tax-exempt investors (such as public pension funds) generally invest in the offshore version of a particular hedge fund. They do this to avoid unrelated business taxable income and to make sure their hedge fund returns aren’t subject to a tax bite. It might be argued, then, that institutional investors need not care too much about the governance of onshore hedge fund vehicles.
Jonathan Morgan at Sound Fund Advisors looks at this differently. He said to me in a recent conversation, “We would expect to see governance that wraps around the entire structure. So, regardless of whether the actual investment is through an offshore or onshore vehicle, an institutional investor should insist on good governance for the entire master/feeder structure.” He further stated that having one type of governance regime for the offshore fund and another for the onshore fund could create a governance culture for the hedge fund advisor that’s “not healthy” for any of the investors.
Here are some observations and excerpts from the report that I thought were particularly revealing:
- In theory, an investor in an onshore US fund should enjoy the same level of oversight and protection that is afforded offshore investors. But the more typical reality is that US-domiciled limited partnerships have no meaningful fund governance of any kind (p.11 of the report).
- It would be a significant step forward if US limited partnerships put in place governance structures (e.g. Governance Committees or Directors at the General Partner level) that provided meaningful oversight and protection for investors (p.12 of the report).
- Many hedge funds have moved towards the preferred model of placing control in the hands of external directors. Specifically, 72% of UK and Commonwealth countries (e.g., Canada, Australia, New Zealand) have control in the hands of external directors while only 44% of US funds do (p. 4-5 of the report).
- Concerning external director control, the US (at 44%) is only slightly ahead of those countries known for their lack of transparency, specifically Asia and emerging markets funds (41%) (p. 4-5 of the report).
If institutional investors continue to pay more attention to governance structures prior to investing, those gains and improvements will help all hedge fund investors and will help to raise the US hedge fund reputation to a world-class level.
April 17th, 2013
Diligence Review Corp.
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