Our performance numbers don't agree!

Last week I had a call from a client who said that the returns they calculate don't match those provided by the hedge fund. How can this be?

Hedge fund performance should be pretty easy to handle: once we have the monthly valuations, cash flows are typically restricted to being once a month (on the last or first day), so it's quite simple to do the math. And so, what might be going on?

Well, our client said that they recognize flows when they occur! This could be the problem, right?

In wanting to get the money to the hedge fund in time that it's available, many of their clients will wire funds a few days early, but the hedge fund pretty much (as I understand it) ignores the money; (i.e., just lets it sit outside the corpus of the fund), until they're ready to bring it in: as a partnership, they do partnership accounting, where they calculate an end-of-month NAV (net asset value), and then issue new shares based on this value and the money being deposited (or, in the case of withdrawals, reduce the number of shares). If our client treats a flow as an intra-month event, using either Modified Dietz or a daily measure (where they simply carry the fund value from the start of the month to every day in the month (since daily values won't usually be available)), differences can occur, yes? There can be other reasons for differences in returns, but this seems to be a likely candidate.

My advice: adopt the same method as the fund. For example, if a flow actually occurs on November 28, but the hedge fund won't recognize it until November 30, having the return reflect the flow on the 28th isn't going to help when trying to match up with the fund. The fund is not doing anything with this cash, so treat the flow as if it occurred on the 30th, just as the fund will. As with all of my posts, I welcome your thoughts.

GIPS isn't that hard for hedge funds

We often get contacted by hedge funds who are considering GIPS(R) (Global Investment Performance Standards) compliance. For some reason they see this as being a monumental task; but it really isn't. Here are some key attributes of hedge funds which make the task a lot easier for them than long-only managers:

1. Hedge funds typically establish separate partnerships by strategy, so they're normally looking at a one-to-one relationship between funds and composites. In other words each composite will likely have only one (or only a few at most) fund(s). Meaning the composite is the fund's return, the composite's assets are the fund's assets, and there is no measure of dispersion.
2. Hedge funds typically limit cash flows to once a month, normally at the end of each month. This means that the funds are valued at month-end before the flows are applied. Therefore, their returns are usually pretty simple to deal with. And, they automatically meet GIPS requirements.

A hedge fund manager's policies will no doubt be easier to implement than for a long-only manager who is more likely dealing  with a lot more diverse accounts.

While it's true that in the institutional, long-only space, one can no longer claim a "marketing advantage" by complying, because virtually all of the firm's peers already comply, this isn't true in the world of hedge funds. Here there is clearly an advantage to make the effort. The investment to comply isn't going to be as great as you'd think, so why not make it?

p.s., for more information on how we can help, please contact Christopher Spaulding at 732-873-5700.

Side pockets & GIPS

The Global Investment Performance Standards (GIPS(R)) don't currently have any rules or guidance specifically geared to the world of hedge funds, which seems a pity. Some think that "everything you need to know is already there," but I don't. Take side pockets, for example.

Side pockets are often employed to move less liquid assets away from the main part of the fund. Investors are typically given an option as to whether or not they want to invest in the side pockets. How should these be handled from a GIPS perspective?

My recommendation: your composite should (a) have the return of the total fund (with the side pocket), (b) provide the return of the fund without the side pocket, and (c) optionally show the return of the side pocket, too.

Hedge funds & GIPS

We are finding more and more hedge funds pursuing GIPS(r) compliance. We are pleased to see such interest as well as to count hedge fund managers among our verification clients.

While some believe that GIPS says everything that's necessary regarding hedge funds, we beg to differ. Dealing with side pockets, fees, and valuations are only a few of the matters which need further clarification.

Some time ago we launched, through the Performance Measurement Forum, a working group to develop guidance for this segment of the market, which would go beyond GIPS and encompass return measurement, risk, and attribution.

Because of schedule conflicts and other priorities, we have permitted the group to languish for a bit, but will soon resurrect it so we can complete our pursuit of this much needed material. Stay tuned for further updates.