Hedge Fund Transparency

In recent years since the financial crisis and scandals like the Bernard Madoff fraud, transparency has become even more important to investors.  Now more than ever, investors are looking for hedge funds of an institutional quality.   In the following video, I discuss the importance of institutionalization and transparency as well as how it relates to running a hedge fund.  This video will be very valuable to hedge fund managers looking to improve their operations.

Video Transcript/SummaryThe strategies and tips provided within this video module include:

  1. Transparency is basically operating and investing within your portfolio so that investors have near 100% understanding of what you are doing and how your hedge fund operates.
  2. Reporting to investors should be done quickly and consistently at least once a quarter.
  3. Establish a very thorough process for hiring.
  4. Be as transparent to investors as possible in your investment process.
  5. Be pro-active in your transparency efforts.

Transcript for Hedge Fund Transparency

Hello, this is Richard Wilson and today we’re going to talk about institutionalization and specifically the importance of transparency, what that means and how to really get some transparent things in place for your hedge fund business. So first of, transparency is basically operating and investing within your hedge fund portfolio in a way that investors have almost 100% see-through of your decision-making processes, your research, your risk management and your investment process and even your team and what they’re doing every day.

So let’s give some examples here and they could really mean. First is risk reporting. Lots of hedge funds have T plus 2 or you know a day or two delayed at risk reporting, somehow same day position risk reporting. Someone may do monthly or quarterly detailed risk reports. It’s important that they’re done consistently, usually the more often the better. Usually you can enable them with technology so that they’re done faster and with less individual manual levels of effort. And on a consistent basis it’s good to send this to your investors proactively, maybe once a month, once a quarter at least, it’s being sent to them so they know that you know what your risk positions are at all times.

And one thing that goes along with that is that if you get in the habit of acting in the right ways in terms of operating in the right ways, operating about looking at intraday risk positions then that’s something you can produce for an investor. And the largest of investors are the ones that are going to do the most checks on how your businesses ran. And one other test might be, if they ask for a risk report, how many days does it take for you to produce that? Does it take a month? Do you say well maybe until the quarter? You know once you response maybe you can provide it back to them in an hour or the same day or the next morning, that’s a world difference from it taking two weeks for a fund that has never had to do that before or that doesn’t have the technology in place to do produce that same report.

So risk reporting is a good example of being transparent. Other transparency could be the very thorough process through which you hire somebody. Everybody knows that a pedigree is one of the most important things for attracting new investors but how many hedge funds when they go and do a due diligence call and talk about not only their investment process but their pedigree investment process. How do they hire very talented experienced professionals? How do they attract more talent per dollar spent than any other competitors? Is it through equity sharing? Is it through vested benefits? Is it through vested profit sharing? Is it through building a strategic board and then slowing hiring on some of those professionals?

I think showing how your business as a hedge fund is advanced enough that you thought through these things and you have a documented, somewhat rigid process for making sure that you had grade A talent for your team is something that the biggest institutional investors will really appreciate because a larger — the more money they have to invest, the larger their organization potentially is and they might have similar systems in place or maybe they realize they should have such systems in place and they’ll respect you for having it already in place.

So I think that that’s another good example, something transparent that you can share. Another thing that ran across most often with emerging hedge fund managers is that they believe that they need to be so secretive. They cannot even share their investment process. And there was a study that came out in 2007 that showed that 86% of institutional investors will not invest in something unless they understand the investment and the investment process behind it. And so I think it is very important that you’re as transparent as possible of your investment process. Maybe your investment process has 4 steps and maybe each of those 4 steps has 5 parts. So maybe what you do is you explain the 4 steps and you provide a summary of those 5 parts.

If you provide some detail but not so much as somebody could copy every little step of your investment process or if your magic sauce is really your research in the inputs under your research system, maybe you share all 20 points of that research, of that investment process and that way you’re more transparent to your competitors, your investors understand exactly all of the different checks you’re doing and processes your following consistently and that can come up stronger than somebody who has 2 percentage a year performance better than yours or even a longer track record but they’re not as transparent.

So that’s another example. Being very transparent on your investment process is another great practical, you know something that you can take away today and start using it as an example of how to be more transparent and how you operate. So in every case within your business, if you look at the 18 or the 12 business functions or strong points about your firm and look at each one and how transparent you are, how transparent your competitors are and how far you could push that line of transparency, I think you’d be rewarded for being proactively very transparent. I agree, there may be an area or two where you want to be less than 100% transparent, or possibly one or two of your reports may only go to investors who have a certain criteria of being the very highly interested or qualified investor.

But in most cases it just kind of benefit you to be more transparent than most or all of your competitors if possible within every area of your business. On some level now, after the Madoff scam there is actually a sense of distrust. At some level nobody trusts anybody. There’s always friends and business that helps smooth things along and get things done quicker, but then when it moves up the chain of command there’s almost always more regimented controls now to have everything checked, due diligence done and things compared and revisited more frequently.

So it’s important to be transparent. I don’t see that trend reversing and you actually make everything smoother for yourself if you’re just transparent upfront. They’ll be less questions and less scrambling to come up with answers and reports down the road when those questions do come up. So thank you for your time today and I hope you enjoyed this video. We’ll see you next time.

Transparency has perhaps never been as appreciated by investors as it is today.  I believe that you will be rewarded for your efforts at increasing transparency and communication with investors.  

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