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October 1, 2019 Brian Robinson
Multiple benefits to allocators who receive transparency exist. However, the realization of the primary advantage of transparency being the transparency process itself often gets missed.
Since the Financial Crisis of 2008, hedge fund transparency has evolved from being a rarity to the norm. Transparency can be provided either directly through managed accounts, or indirectly through aggregators who receive the position files and show the effects of these holdings (exposure, risk description) but blind the position names to investors. Exposure decomposition, statistical and factor analysis from holdings, P&L analysis, and analysis of changes in portfolio composition over time all offer meaningful information to hedge fund allocators.
Most significantly, managers who offer transparency to investors are giving a form of proof that the money allocated to a fund by investors is, in fact, going into securities rather than being fraudulently diverted into an illegal scheme. Certainly, a fraudulent manager might still find a way to siphon money away from a fund, but transparency makes this more difficult. A classic example would be Madoff's "split-strike collar" strategy. If anyone had transparency into this fund, they would have seen that there were no security holdings at all. Of course, a manager executing a Ponzi scheme probably wouldn't offer fund transparency, which makes refusing to participate a red flag in and of itself.
Due to the investment structures that hedge fund vehicles use, and despite all the due diligence, trust, and monitoring that allocators perform when allocating money to hedge funds, allocators must rely on good faith that the fund managers are honest stewards of the assets given to them.
Managed Accounts overcome this concern as investors usually have full, daily or real-time visibility into their holdings. But Managed accounts require either significant capital to compel the manager to create such an account or require additional fees when pooled managed accounts are created via a platform.
For traditional allocators to commingled hedge funds, transparency programs can help assure and verify the use of their assets in a manner consistent with expectations.
Transparency programs generally work as follows:
Above all, an allocator's job is to be a good steward of client trust and assets. Avoiding fraud is job one, and holdings-based transparency is an essential tool in the due diligence process. Having worked both for a FoHF where we required transparency from our managers as a condition of investment, to two transparency services (RiskMetrics HedgePlatform and now Vidrio), I have watched the evolution of this feature of hedge fund investing evolve firsthand. In all, transparency is a benefit to allocators with a fiduciary duty to ensure client monies are being responsibly handled.
For further information regarding the Vidrio platform and how we can help your business, contact a member of our team.
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