Regulators want it. Investors may want it more.

It's called transparency - a term which broadly reflects a glimpse into the investment strategy, risk and operations of hedge funds. A study of 200 institutional investors, managers and administrators just released by KPMG International on the future of the hedge fund industry showed that 68% of institutional investors cited transparency as the biggest challenge for fund managers to deliver this year about their operations.

The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act provides some guidance for hedge fund managers which must register as investment advisers.

"At a high level, the financial reform bill may require that hedge funds provide the Securities and Exchange Commission with additional specific and potentially proprietary information on their operations and investments such as information on their valuation practices and counterparty risk exposure," says Kathryn Furman, a partner with the law firm of King & Spalding in Atlanta.

But for investors, such guidance may seem too little too late. The financial crisis and the Bernard Madoff fake-trading scandal prompted firms to take a "trust but verify approach." That means demanding a lot more information from service providers who work behind the scenes. Making sure data coming in and going out is correct could increase staffing requirements and even IT costs for some third-party firms - namely administrators - at a time when budgets are tight.

Vernon Barback, president and chief operating officer at GlobeOp, a New York hedge fund administration firm servicing $121 billion in assets, says that last year pension funds and other institutional investors increased their "due diligence" visits and questionnaires with GlobeOp in New York and overseas by more than 30%.

The goal: to ensure that the administrator's operations and risk controls are consistent worldwide and match up what has already been disclosed in the fund's private placement memorandum and valuation policy.

"We're setting up due diligence teams to meet with institutional investors worldwide after completing their due diligence questionnaire," confirms Brian Ruane, CEO for the alternative services unit at Bank of New York Mellon, which has $315 billion in alternative assets under administration. Those due diligence teams include not only marketing and senior relationship staff but also technology and operations executives.

Among the two top questions asked by institutional investors: What are the procedures you use to value your assets?, and - How do you verify that the fund manager has actually executed the orders?

"The valuations cannot be correctly determined unless there is first an accurate understanding of the hedge fund's exact holdings and transactions," says Barback. "That is where confirmation and reconciliation comes into play."

GlobeOp in June launched a report to provide investors with greater visibility into the monthly calculation of a portfolio's net asset value. Delivered online as part of monthly investor statements, the report outlines the percentage of assets and liabilities independently confirmed by GlobeOp, a percentage breakdown of third-party exposure and the liquidity of the portfolio according to fair-value accounting principles.

The report also discloses the percentage of asset valuations based on prices received directly from the manager, or confirmed independently by GlobeOp. The report's data comes from GlobeOp's trade processing system and portfolio accounting platform, which also reconciles the books and records on trades executed by the fund manager against data from prime brokers or other counterparties.

"Valuation experts are now being treated with the same level of importance as other critical service providers, such as prime brokers and administrators," says James Coley, director in the portfolio valuations service at Markit, a global financial information and post-trade processing firm in New York. "Not only are investors visiting us, but so are their accountants."

In addition to providing customers with the sources of data and how pricing models work, Markit offers liquidity metrics which give the fund manager an indication of how close to the market price it can buy or sell credit default swaps and bonds. Markit is beta testing the same service for syndicated loans and asset backed securities.

When it comes to risk reporting, granularity is the operative word. For the past two years, Sophis, a Dublin-based provider of portfolio and risk management software, has been offering hedge fund investors daily Value at Risk reports and real time assessment of the impact to the profit and loss of a hedge fund depending on a market shift, such as a change in interest rates.

However, fund managers still have plenty of leeway in the information they allow Sophis to provide to investors, says Eric Bernstein, chief operating officer for Sophis, N.A. Easy-to-understand reports on stress test and scenario analysis might typically be distributed while more complicated reports using Monte Carlo simulations to calculate Value at Risk might not.

Among the other types of portfolio metrics that institutional investors might ask for: volatility and standard deviation as well as alpha over industry benchmarks, delta and beta adjusted exposure, gross and net exposure over time, relative and absolute attribution and stock selection versus asset allocation.

Ron Suber, senior partner for Merlin Securities, a prime brokerage firm in New York, says his firm can aggregate information in real-time from all of a hedge fund's prime brokers and custodians and make those types of analytics accessible to a hedge fund investor on a daily basis over the web.

But there is one type of data which hedge fund investors must still depend on their manager to provide - the use and cost of leverage, says Josh Galper, managing principal of Finadium Partners, a Concord, Mass., consultancy. That means information on a fund's securities lending activities, margin, use of securities such as options which have built-in leverage and the extent and cost of swaps transactions.

"Investors may not want details on the market price of each securities loan, but may appreciate summaries that show that the fund itself understands its use and cost of leverage," Galper said. "They may also want a basic understanding that the fund is getting charged fairly for its securities loans compared to a broader market."

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