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Posts tagged ‘hedge fund’

US Hedge Fund Governance Continues to Lag

May 1st, 2013

Jennifer Cooper

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.

5 Biggest “Form ADV Review” Mistakes

April 17th, 2013

Diligence Review Corp.

A handful of organizations are best-in-class with respect to Form ADV Reviews.  We recently worked with Stefan Whitwell to produce an Executive Briefing on the “5 Biggest Form ADV Review Mistakes” that we’ve seen happen over time.

Stefan Whitwell, CFA, CIPM, is a Managing Director at Empirical Solutions, LLC, a leader in field of risk management, public pension due diligence and fund governance.

Please take a look at this complimentary Executive Briefing:

Hedge Fund Case-Study on Weavering

November 27th, 2012

Jennifer Cooper

The Importance of Being Diligent is a website that provides helpful information to investors about hedge fund due diligence.  The site has posted a new item, “Case No. 9 Weavering.”  This case study, prepared by Sus Volans, is well-researched, detailed and highly readable.  The Weavering post provides hedge fund investors with 7 specific recommendations on how to be aware of this kind of fraud in the future.   It’s worth reading.

Form PF & Investors: Will the Invisible Hand Work its Magic?

August 30th, 2012

Jennifer Cooper


Yesterday, large hedge fund investment advisors (those with regulatory AUM of $5 billion and more) hit the “send” button and transmitted their Form PF data to US regulators.  The Securities and Exchange Commission, the Commodities Future Trading Commission and the Financial Stability Oversight Council are now busily reviewing an unprecedented amount of advisor-supplied hedge fund information including liquidity levels, counterparty information, leverage, risk metrics, collateral, and hedge fund performance data.

Form PF was conceived in an effort to make the financial markets safe.  So it seems odd that the investor – whose money it is – is completely left out of this information loop.

Based on our conversations with large investors, a number of them will request Form PF data from their hedge fund advisors.  With luck, the market’s invisible hand will work its magic and these advisors will release data to their clients, upon request.   We’ll see.

Some professional investors are looking forward to the opportunity to gain access to standardized “point-in-time” data for each of these investment funds. Other professional investors are pleased with the information they are currently receiving.  It’s our sense that many private hedge fund investors, especially individuals and families served by private banks, know little about Form PF and the wealth of information that has been prepared about their investments.

Investors who are planning to request Form PF data from their hedge fund advisors might consider adopting some practices around that activity.  Specifically,

  1. Determine under what circumstances and how often Form PF data is to be requested from hedge fund advisors. Will you request Form PF information from all of your hedge fund advisors?  Or only from funds that you currently consider more risky?  Will you request this information when hiring new hedge fund advisors or will you request it only from existing advisors?  Will you examine it once or do you intend to monitor fund changes over time?
  2. Determine who is to review Form PF data. Should the investment team lead this effort?  Or the audit team?  Or will your investment consultant perform this function?  Form PF data is submitted electronically by hedge fund advisors.  If you request the data, there’s a chance that it might be sent to you as an electronic XML file.  You might need to include your IT team to assemble the data into a useable report format.
  3. Determine whether and to what extent SEC Form ADV information should be included in the review.  Form ADV, the primary investment advisor regulatory document, was updated by the Securities and Exchange Commission in 2012 to require much more useful information from advisors.  Since March 2012, most institutional hedge fund advisors have also been completing Form ADV, which requires advisors to submit information about their regulatory violations (if any), related parties, potential conflicts of interest, and other key information about each private fund they manage.  Has the new Form ADV information been reviewed for each hedge fund advisor?  Should the Form PF review be done in conjunction with the periodic Form ADV review?
  4. Examine Form PF data to uncover any risk items or new information.  A person or team within the organization should be empowered to review the Form PF data in conjunction with the existing known hedge fund information to uncover any irregularities, risk items, or new information.  For example, if a hedge fund advisor has drifted into Level 3 assets but previously stated in documents that only Level 1 and Level 2 assets would be managed, this could be considered a risk item.  Information about key investor rights, previously unknown to the investor but disclosed in Form PF, could be considered new information.
  5. Determine precisely what is to be done with risk items and new information uncovered, if any, and how those facts enter into the investment decision-making process.  It’s important that any uncovered risk items or new information be transmitted to decision-makers for consideration and/or entered into the appropriate investment decision-making process.
  6. Establish clear communication between investment teams, audit teams, consultants, trustees, and other key decision-makers concerning Form PF.  To produce the data required by Form PF, hedge fund advisors quickly learned that many different parts of their organization needed to pull together and work collaboratively in new ways.   Investors reviewing Form PF data may have to collaborate internally and in new ways in order make best use of the information.

Investors, advisors and regulators are all moving into unchartered territory concerning Form PF.  We often sign non-disclosure agreements in our work and we expect to review Form PF data on behalf of some investors.  Based on our experience reviewing Form ADV, we believe many investors will learn very useful new facts about their hedge fund investments through these new Form PF filings that will assist their risk management efforts.    It will be interesting to see how this unfolds over the next six months.

For more information about Form PF and the type of data requested in Form PF, please see our Form PF and Hedge Fund Investors, 6-page whitepaper dated May 1, 2012.