It seems lost in the mists of market meltdown now, but hedge funds were widely blamed at the start of the financial crisis for practices that triggered the collapse.
Since then, the industry has closed ranks but now feels secure enough to accept a degree of criticism.
A White Paper reviewing the role of non-executive directors in the hedge fund industry has found significant failings in the services provided. The document, published by independent consultant HedgeDirector, claims directors of offshore hedge funds are frequently ‘under-qualified’ and ‘over-stretched’, and says they fail to deliver an adequate standard of governance.
The report recommends hedge fund investors become more vocal and insist on professional standards of oversight from the offshore boards.
The research comes in the wake of similar criticism by large investors, but could apply to other structures. HedgeDirector’s founder Kevin Ryan argues the reforms being enacted in traditional fund governance, following the Walker report in the UK and Dodd-Frank Act in the US, should equally be applied to the world of alternative investments.
As institutions allocate a greater percentage of their portfolios to hedge funds, they have to demand the same ‘best practice’ governance from their hedge fund boards as they do from their traditional investments. The same duty of care is owed on both.
The report highlights the continued prevalence of conflicted non-executive directors who tend to come through hedge funds’ offshore service providers or their affiliates. This practice gives rise to the perception the non-executive directors are merely rubber-stamping the decisions of the manager, and not operating freely in the best interests of the fund and its shareholders.
Instead, the majority of every board should be staffed by directors who are clearly independent of undue influence by the fund manager, the report says.
The size of directorship portfolios are another contentious area. Some directors are on the boards of hundreds of different funds, a situation Ryan says reflects very badly on the modern hedge fund industry.
Directorship portfolios of this size are “unacceptable” and offshore regulators should place limits on the number of directorships, and make public the lists of positions held by each individual, he adds.
The skill sets of the board also come under fire, specifically for a lack of asset management expertise. The paper quotes the advice of the Alternative Investment Management Association and the Hedge Fund Standards Board and says without fund management experience in the boardroom, the board is not properly qualified to monitor the portfolio manager.
Even now, in the wake of high-profile fund blow-ups and the financial crisis, the majority of boards contain little or no actual portfolio management experience. As a consequence of these missing skills, Ryan notes that “in practically every hedge fund collapse to date, the offshore directors have missed the danger signals and provided no advance warning to investors”.
The HedgeDirector paper calls for more thorough due diligence on the identities of the non-executive directors and further pressure on hedge funds to raise the quality of their boards.
With increasing institutional investment, and more regulatory focus on hedge funds, it has become essential for hedge funds to provide their investors with a higher standard of governance than the industry has historically tolerated. More asset management professionals need to become involved as non-executive directors, while hedge fund managers and fund-of-fund managers should make themselves available for these roles.
Delegates at Investment Week’s European Breakfast Briefing last month heard from a number of fund managers discussing the region’s prospects.
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