New Year resolutions look at hedge funds future in 2009

New Year is traditionally the time to take stock of the past year and look forward with hope and renewed energy to the year to come. In most countries at the stroke of midnight the New Year is heralded in by making a lot of noise. The origins of this behaviour stretch back hundreds of years to a time when people believed that making a lot of noise would scare away the evil sprits.

If only it were that simple today. Given that 2008 had more than its fair share of disastrous events, one can only hope that 2009 will have fewer evil spirits lurking in the shadows. Whatever the case it is unlikely that a bit of noise will be enough to disperse the clouds of doom hanging over the financial sector.

This year will not be easy. The fallout from the latest fiasco to rock the financial world - the alleged fraud of Bernard L Madoff Investment Securities - has repercussions yet to be felt. It needs to be said at the outset that anyone intent on committing a fraud - and certainly a person as clever as Madoff - will find a way of doing it.

However, it does appear at first glance that several investors were incredibly lax in due diligence and were bewitched and bedazzled by promises and big names, rather than cold hard facts and analysis. These were supposedly savvy investors, some of the best managers, who should have been able to spot something that was just too good to be true. Obviously hindsight always gives perfect vision. The US tolerance of allowing front and back office to co-mingle has been seriously exposed for the danger it poses.

The scandal also shows how vulnerable the hedge fund sector still is to adopting the mantle of scapegoat. Madoff's business was not a hedge fund. Nevertheless, almost every media report calls it just that, adding to the already negative image the fund sector managed to garner in 2008.

Just when it seemed that reason rather than knee-jerk reaction would dominate legislative thinking, particularly in the US, Madoff happened. No chance now of avoiding what will probably be costly, ill-conceived and punitive rules in the US.

Looking back over 2008, it seems almost inevitable that something on the scale of Madoff was bound to hit the world in the final month. There is a limit as to how many more shocks the financial system can take.

Trust was already a forgotten term among the banks. Following Madoff it seems even more likely than restoring that trust (and consequently credit and liquidity) to the system will be that much more difficult.

But ever optimistic, Hedge Funds Review has a couple of New Year resolutions for the hedge fund industry that could help bring a sliver of light to the dark skies, as well as foreshadow a better and more secure industry for the future.

More than ever in 2009 it will be important for the hedge fund world to prove to politicians, regulators, investors and the general public that they are an essential part of the financial landscape and are quite capable of self-regulation. The standards are by far the best in existence. Although they may be daunting for start-ups and smaller funds, they can still comply in principle.

These standards are important. They show that the industry has enough confidence in its worth to care about how it behaves. Hedge funds are still misunderstood and mysterious to the average man on the street (and probably the average politician as well). Being able to point to a voluntary code of conduct that is endorsed by the investment community and promotes good corporate governance is a powerful weapon to deflect criticism the next time a financial mess lands on the doorstep.

The standards should also fend off any ill-conceived ideas of politicians (particularly those in the European Parliament and the more protectionist EU member states) keen to curb the innovation and free spirit of London's financial sector.

While it will not be able to stop the US government rushing into costly and no doubt useless legislation, it will give investors added assurance that funds are trying to the best of their ability to behave as responsible members of the financial community and above all to protect investors, while at the same time producing above-average returns.

This will not be easy. Hedge funds do not shout about their strategies for good reasons. One is that most people would not have a clue. Another is that in general, regulations prohibit them being seen to be 'marketing' funds to the public.

Many interpret that injunction as a blanket ban on speaking to the press. Rubbish. It is time more funds spoke to the press. This is a double-pronged offensive: charm and education. Not only the public but politicians (and investors) will take seriously comments in the media about hedge funds, even when it is blatantly incorrect.

It is necessary to help educate reporters in the complexities and intricacies of the hedge fund world to ensure a more balanced reporting the next time a hedge fund pops into the limelight. The stereotype of the fund managers' millionaire playboy lifestyle may be far from the truth, but it is one that sticks. The secrecy and silence surrounding much of hedge fund activity only fuels speculation and conjecture. Far better to start giving some facts to the media than letting them imagine them.

Likewise it is time to start a communication charm offensive with investors. The less than stellar performance of some funds has spooked investors. Funds will need to woo them back and make sure those that have stayed continue to have confidence in them. More, better and closer communication with investors should be high on the list of priorities for any fund in 2009.

All the signs are that more, not less, money will flow into hedge funds once the dust clears. Despite the widely publicised closures and redemptions, and almost across-the-board negative performance, hedge funds are still the best option around. The meltdown of the equity markets illustrated to investors the wisdom of hedge bets, particularly with hedge funds.

Cultivating and keeping close to investors will be even more necessary in 2009. Funds will want to make sure that the next time the going gets tough, investors do not desert in droves. Whether this means re-negotiating the fee structure or making it more difficult for investors to treat funds like cash machines by placing barriers to redemption, is going to be an interesting debate.

Whatever the outcome, funds that do not already have good, comprehensive communication with investors will find it essential from now on.

Funds will also need be a lot more proactive in engaging with the public. Cultivating a good press will be difficult but to avoid being a scapegoat every time something goes wrong should be a strong incentive to educate them about why hedge funds are not just essential but are actually beneficial for markets and the financial system.

While the majority of New Year resolutions are broken before the first month ends, it would be a wise hedge fund industry that tried to at least keep the spirit of these two simple resolutions alive for the majority of the year. 2009 promises to be a challenging year for even the best of fund managers.

There will no doubt be some radical changes, consolidation and contraction. Whatever the outcome, however, hedge funds will remain a valuable and essential part of the financial landscape for many years.

Resolution 1: Sign up to the Hedge Fund Standards Board standards. If already signed up, encourage others to do so, too.

Resolution 2: Learn how to communicate.