In light of recent high-profile hedge fund fraud cases, Bernard Madoff notwithstanding, hedge fund investors are much more careful about transparency than they are performance when selecting a fund, according to Standard & Poor’s.
It will take “more than deft trading strategies to return to their former glory days and once again attract investors,” S&P says.
After losing $1 trillion in assets in the market downturn, flows are returning to hedge funds once again, but they are likely to be guarded. Likewise, volatility in hedge fund portfolios appears to be lower due to a reduced risk tolerance.
Another plus is that due to the market shakeout, hedge funds have been able to recruit high-level, experienced talent without guaranteeing exorbitant bonuses.
Regulation is one area, however, that could change hedge funds forever, particularly if they are restricted on short positions or alternative investments such as derivatives. In anticipation of more stringent regulations, many hedge funds are reducing their leverage.
Hedge funds are likely to increase their transparency as a form of goodwill to investors, even if it is just a third-party audit. “The highest-rated funds are those that provide the greatest transparency and demonstrate the most developed infrastructure and culture of risk controls,” S&P says.
Hedge funds could offer investors dated investment strategies “to bring across the relevant points in public statements. In some cases, we’ve observed funds create investor letters with sufficient detail that investors can adequately judge the merits of performance and risk attribution,” S&P says.
Finally, investors have also become sensitive to lock-up periods, investment portfolio liquidity nd risk management.