Hedge funds' lack of op risk disclosures a concern

Hedge fund investors highlight concerns about hedge funds' disclosure on liquidity and operational risk exposures

LONDON - A survey published by French business school Edhec has highlighted concerns of hedge fund investors about disclosure on liquidity and operational risk exposures at hedge funds even before the Madoff scandal was made public.

The Edhec Hedge Fund Reporting Survey, which targeted 214 hedge fund managers, fund of hedge funds and hedge fund investors in the summer of 2008, found that 80% of respondents felt liquidity risk was not sufficiently captured in hedge fund reporting. Some 92% of respondents stated the quality of hedge fund reporting was an important signal of a fund's overall quality and pivotal to investors' decisions about hedge fund investment. But the information disclosure was viewed as inadequate by investors with information on fund liquidity and operational risk exposure viewed as incomplete.

The industry views issues related to the pricing and valuation of hedge funds (identified by more than 76%) as the most crucial elements of operational risk reporting. Information on internal risk management (60%) and internal controls (48%) are also seen as major aspects. When asked whether the information provided on operational risk is sufficient or meets their demands, investors reply that exactly those aspects that are considered most important are those that are considered most wanting; that is, information on a fund's valuation framework and on the internal controls a fund puts in place.

Liquidity risk is considered a major source of risk for hedge funds, especially for hedge fund investors - more than 80% of respondents classified this source of risk as "very important" yet the current coverage of liquidity risk in hedge fund disclosure is described as insufficient by the majority of investors.

Edhec also commented that guidelines and best practices issued by industry associations such as the Hedge Fund Standards Board and Alternative Investment Management Association fell short of providing sufficient guidance on hedge fund disclosure.

"These guidelines... rarely provide guidance on sound hedge fund disclosure. Many of the guidelines are vague and cover topics that are already standard disclosure," the survey said.

A copy of the survey can be downloaded here: