If you think, like many, that “an instrument that has a daily standard deviation of 1% should move 1% a day on average", you should read the following article:
Goldstein, Daniel G. and Taleb, Nassim Nicholas, We Don't Quite Know What We are Talking About When We Talk About Volatility (March 28, 2007). Journal of Portfolio Management, Vol. 33, No. 4, 2007. Available at SSRN: http://ssrn.com/abstract=970480
2010/12/18
The due diligence process according to John Mauldin
John Mauldin is among other things a serial writer and an acute investment professional. I enjoy very much reading his Thoughts from the Frontline e-letter or the various articles he features in his outside the box letter.
He has posted a draft chapter of his new upcoming book about Absolute returns on his website (http://www.accreditedinvestor.ws/downloads/Due_Diligence.pdf). The name of the chapter is "Evaluating Hedge Funds" and describes his approach to due diligence.
Also it is quite challenging to describe a due diligence process in only 22 pages, I noticed a few ideas which are worth considering in your analysis of an hedge fund:
• Some hedge fund managers are good and some are just lucky. You do not want to invest in the lucky one, as luck always run out, typically just after you invest.
• The business side of the fund is as important as the investment side.
• The most important thing to understand about a fund is "Why" it makes money. If you cannot understand the "Why" of a fund, you should not be investing.
• A brilliant manager who can't follow through on the paperwork is a disaster in the making.
• Second level references are far more informative that the given references
He has posted a draft chapter of his new upcoming book about Absolute returns on his website (http://www.accreditedinvestor.ws/downloads/Due_Diligence.pdf). The name of the chapter is "Evaluating Hedge Funds" and describes his approach to due diligence.
Also it is quite challenging to describe a due diligence process in only 22 pages, I noticed a few ideas which are worth considering in your analysis of an hedge fund:
• Some hedge fund managers are good and some are just lucky. You do not want to invest in the lucky one, as luck always run out, typically just after you invest.
• The business side of the fund is as important as the investment side.
• The most important thing to understand about a fund is "Why" it makes money. If you cannot understand the "Why" of a fund, you should not be investing.
• A brilliant manager who can't follow through on the paperwork is a disaster in the making.
• Second level references are far more informative that the given references
2010/12/08
Hedge Fund Appraisal annonces the launch of the Research Gateway
Learn how it works by watching our multimedia presentation
The research gateway presentation
View more webinars from hfappraisal.
2010/07/06
Cost of information is a barrier to self-regulation
The graph below is from a survey conducted in 2009 by Ernst & Young named Global Hedge Fund Survey: Weathering the storm published in November 2009. It is not a surprise that the 100 hedge funds surveyed prefer an investor driven change rather than a costly and efficiently questionable regulation.
I agree that investors should be more demanding from their hedge fund managers in terms of transparency. However, the only way for the industry to be effectively "policed" by its investors is to lower the cost of information.
In a paper, Board Structure and Price Informativeness, forthcoming in the Journal of Financial Economics, The authors find evidence that stock market monitoring is a substitute for board monitoring. Access to reliable information at a reasonable cost is what makes it possible.
The day when investors will be able to compare hedge funds on an apple to apple basis, the industry will be a safer place to invest.
2010/07/05
Reducing insider trading risks at hedge fund advisers
Andrew Vollmer, a partner in the Securities Litigation and Enforcement Group at Wilmer Cutler Pickering Hale and Dorr LLP published “How hedge fund advisers can reduce insider trading risk,” in the Journal of Securities Law, Regulation & Compliance, Vol. 3, No. 2 (2010).
The article discusses some of the approaches that hedge fund managers use to prevent insider trading violations. They include avoiding agreements to keep information confidential and giving heightened attention to business communications between hedge fund personnel and close family members or personal friends. The article also describes the many legitimate reasons that analysts at money managers have to communicate in private with senior management of public companies and ways hedge fund advisers can police the insider trading risks associated with those communications.
The author has covered the topic from a legal perspective describing methods used to avoid being "brought behind the wall" unintentionally. However, the article does not discussed the way to avoid the intentional insider trading practices revealed recently at some well known hedge funds. As discussed, recently in my blog, the identification of fraudulent practices at hedge fund advisers is an arduous task. A dedicated compliance/legal department and pre-trading systematic compliance checks are good safeguards to avoid insider trading.
The article discusses some of the approaches that hedge fund managers use to prevent insider trading violations. They include avoiding agreements to keep information confidential and giving heightened attention to business communications between hedge fund personnel and close family members or personal friends. The article also describes the many legitimate reasons that analysts at money managers have to communicate in private with senior management of public companies and ways hedge fund advisers can police the insider trading risks associated with those communications.
The author has covered the topic from a legal perspective describing methods used to avoid being "brought behind the wall" unintentionally. However, the article does not discussed the way to avoid the intentional insider trading practices revealed recently at some well known hedge funds. As discussed, recently in my blog, the identification of fraudulent practices at hedge fund advisers is an arduous task. A dedicated compliance/legal department and pre-trading systematic compliance checks are good safeguards to avoid insider trading.
2010/07/02
Administrators become transparency providers
Hedge Fund managers are usually very cautious regarding the level of transparency they provide to their funds' shareholders. The reasons invoked by the managers for such secrety are usually their fear to see their investment strategy reverse engineered or other investors betting against them. Even if the managers provide investors with some granular information about the fund's portfolio, this information partiality can be questioned.
However, their is one person for whom the hedge fund manager has no secret.This is the fund's administrator. In order to perform its duties, the administrator needs to have access to detailed information about the fund's portfolio. In most cases the information is gathered directly from the fund's counterparties.
Following investors' demand for more transparency, some administrators understood, that they were in the best position to provide this additional disclosure in an independent manner. Today, at least three of them (Citco, Morgan Stanley and Globop), are proposing transparency reports to investors for funds which have elected to propose this service to their shareholders. The managers can decide which level of transparency they want to provide.
A common layer of transparency proposed by the three administrators is a report providing information about the NAV calculation process. The information included in those reports can cover pricing sources, position reconciliations, fund assets and liabilities, counterparty risk concentration, portfolio liquidity and where assets are held in custody.
According to the Q4 2009 HFN Administrator Survey, the three above mentioned administrator had assets under administration at the end of 2009 totalling $582.44billion which represents approximately 25% of the total hedge funds assets.
The tools for more transparency into the opaque hedge fund industry are available, investors need now to use them and put pressure and their managers and the fund's administrator for a broader generalization of those practices.
Related links
http://www.morganstanley.com/about/press/articles/9bcef2d6-5463-11de-96f6-3f25a44c9933.html
http://www.globeop.com/globeop/proserv/fund_administration/fund_performance_reporting/
http://www.citco.com/Divisions_Transparency_Platform.jsp
However, their is one person for whom the hedge fund manager has no secret.This is the fund's administrator. In order to perform its duties, the administrator needs to have access to detailed information about the fund's portfolio. In most cases the information is gathered directly from the fund's counterparties.
Following investors' demand for more transparency, some administrators understood, that they were in the best position to provide this additional disclosure in an independent manner. Today, at least three of them (Citco, Morgan Stanley and Globop), are proposing transparency reports to investors for funds which have elected to propose this service to their shareholders. The managers can decide which level of transparency they want to provide.
A common layer of transparency proposed by the three administrators is a report providing information about the NAV calculation process. The information included in those reports can cover pricing sources, position reconciliations, fund assets and liabilities, counterparty risk concentration, portfolio liquidity and where assets are held in custody.
According to the Q4 2009 HFN Administrator Survey, the three above mentioned administrator had assets under administration at the end of 2009 totalling $582.44billion which represents approximately 25% of the total hedge funds assets.
The tools for more transparency into the opaque hedge fund industry are available, investors need now to use them and put pressure and their managers and the fund's administrator for a broader generalization of those practices.
Related links
http://www.morganstanley.com/about/press/articles/9bcef2d6-5463-11de-96f6-3f25a44c9933.html
http://www.globeop.com/globeop/proserv/fund_administration/fund_performance_reporting/
http://www.citco.com/Divisions_Transparency_Platform.jsp
2010/07/01
The financial crisis’s “Ponzi schemes” blowing effect
(Photo:Ponzi aka "Charles Bianchi" under arrest circa 1910)
The last financial crisis has had a stunning side effect in uncovering "Ponzi schemes".
In fact, in order to keep a "ponzi scheme" going, the investment "fraudster" needs only one thing: liquidity. As long as the amounts subscribed into the fund exceed the amounts withdrawn, the credulous investors will probably feel confident that they made a good investment decision. The liquidity crisis engendered by the financial crisis had the effect of destabilizing the good operation of some Ponzi schemes especially the ones who were offering short liquidity terms.
A search on the SEC website for the word "Ponzi" returned 294 litigation matches for the period between September 1st 2008 and June 30th 2010 compared to 144 matches for the preceding 20 months period. The matches do not always represent separate cases but the difference between the two numbers unquestionably demonstrates the positive effect of a liquidity crisis in blowing up "Ponzi schemes".
The last complaint of the SEC against an alleged ponzi schemer was filed on June 17th 2010 against Daniel Spitzer and the investment companies and funds he controlled (click here to read the full text of the complaint). It is worth noting that once again the victims are individual US citizens invested in an LP vehicle with no third party administration. The complaint does not explain why the different entities involved in managing the funds were not registered as investment advisers with the SEC despite the fact that they were supposedly managing around $100ml for 400 investors.
We are now 20 months after the collapse of Lehman Brothers which triggered the huge run to the bank experienced by so many "liquid" funds; it is fair to assume that most of the pure "historical Ponzi schemes" have now been uncovered. However, investors beware not to become too complaisant as fraudsters are always waiting for the right moment to catch you off-guard.
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