- 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.
- 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.
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?
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One has to wonder why the hedge fund world seems to have suddenly "gotten religion" regarding the value of GIPS compliance. It only took them 20 years? We really have to ask the question: "Why now?" Could it be that the hedge fund world NEEDS some way to restore credibility and stem the tide of distrust that has gripped the investing public in the aftermath of the Madoff scandal?
ReplyDeleteTrue, the public has only itself to blame for "trusting but NOT verifying" the returns of hedge funds whose performance seemed to defy gravity. Their lack of transparency was almost a badge of honor at one time, as though their claim of having a "secret sauce" that drove their stellar performance record were enough to calm the concerns of investors who should have done their own due diligence on BOTH the investments and the operations of the hedge funds to whom they gave their money.
This brings us to the problems of hedge funds seeking GIPS compliance. We really do need to answer the question: "Why now?" I suspect that hedge funds (and investors) expect that a claim of GIPS compliance along with VERIFICATION of this claim of compliance will address the issue of FRAUD. It will not. Clearly, GIPS compliance cannot be expected to be a protection against fraud (at least, not in the current environment of GIPS.) Therefore, it must be the responsibility of performance staff and especially of verifiers to make it clear that GIPS compliance and verification are not meant to guarantee against fraud. (It would help if verifiers took a more active role to act with a greater degree of skepticism in their evaluations, but that's another story...)
Perhaps it's good news that GIPS compliance for hedge funds is increasing in interest, but that's not good enough. Hedge funds need to do the right thing for the right reason. The right reason is the spirit of GIPS: serving the investing public by improving standards for performance and providing a level playing field with increased comparability. The wrong reason is reacting to recent bad press with a "feel good" measure that is sure to disappoint if the current misunderstandings regarding GIPS are allowed to persist.
Steve, very insightful comments; thanks! I believe that the Madoff scandal DID contribute to the interest in GIPS compliance for hedge funds. I also believe that the higher degree of scrutiny placed on this sector by the SEC, the congress, and others, is also at work.
ReplyDeleteWhile I agree that achieving compliance for the "right" reasons is ideal; however, even if one moves towards compliance in response to negative reactions is still good for our industry. The fact that some firms have "found religion," regardless how, should prove beneficial in the long term.
The reality is that many firms become compliant solely in order to compete effectively; is that a "bad" reason? While we would like firms to see the core benefits in compliance, the reality is that the drivers can be varied. Using the religion metaphor once more, do we really care what brought someone to Church? A sense of guilt, a loss of a loved one, a challenge in their live? The fact that they "found religion" is praised, and I think it applies here, too.