Hedge Funds Wake Up to Transparency

Dodd-Frank’s impact on the buy side hasn’t entirely come to pass, but it has already caused a huge cultural shift in the ranks of hedge fund managers.

The days of secrecy are over, according to a panelist at the Advanced Trading Buy-Side Summit, an exclusvie conference for buy-side traders in Amelia Island, Florida this week, who said hedge funds are learning to be more transparent in discussions with regulators and clients.

Prior to Dodd-Frank, hedge funds could dodge questions about their strategies, claiming it was their proprietary secret sauce, but in the wake of the credit crisis when two Bear Stearn’s hedge funds imploded and Bernard Madfoff’s Ponzi scheme, regulators will expect an articulate explanation of their investment style and performance.

“If you are able to talk about that thoroughly and openly and what you are investing in and give them an overview of your portfolio, I think they appreciate that,” said a panelist who runs a hedge fund. Regulators are looking at documents, at the names of the firm’s accountants and auditors, said the hedge fund manager.

Translation: In the post-Madoff era, it’s not a good idea to hire a two-person accounting firm based in a storefront strip mall. The problem is, by hiding behind an intense veil of secrecy, hedge funds have brought the scrutiny onto themselves. “I think it was detrimental to us,” said the hedge fund panelist. Their unwillingness to speak about what securities their portfolios contained or the returns generated by their investment, has backfired on them, he suggested. “Now as a result of Madoff and Dodd-Frank smaller funds and the larger funds realize we have to be more transparent, we have to be able to talk real and feel that we are not living in some cloud.”

How does a hedge fund achieve transparency? Is it through better reporting to clients, or through discussion of counterparty risk? The new era of transparency is more than filling out paperwork; it requires a new ideology at the hedge fund where there is an open dialogue and a policy to converse and hear everybody’s perspective, explains the panelist. “That is how you set up a firm of transparency.”

This particular firm offers its clients monthly reports and if a client happens to call and ask for the net asset value (NAV), it’s happy to tell the client what they’re doing. As a result, during the recent market gyrations, the firm didn’t receive a single call, because the clients speak to firm on a monthly basis and the manager sends out a newsletter.

Meanwhile, automated trading firms are also finding that they must disclose more than in the past. One panelist who heads a proprietary trading firm recently made the decision to scale the operation into accepting assets from high-net worth investors. “This is going to be new territory for us,” said the panelist, acknowledging the trust factor of dealing with high-net-worth investors.