The Hindu Business Line : On the edge of hedges

More than one in four hedge funds go out of business, say statistics; but "because many funds, especially struggling upstarts, do their business outside the public eye, the failure rate may be much higher."

Chennai , May 28

Hedge funds have been a heady stuff. But the latest news sounds alarm. `Hedge funds in a spin,' reports Independent, UK. `Next scandal? Try hedge funds,' teases St. Petersburg Times.

And, `Hedge funds: Mere mortals after all?' opines Chicago Tribune, `11 minutes ago'. In this report, Gail MarksJarvis writes, "Hedge funds are thought to be the wealthy investor's Superman - funds that are able to leap tall buildings in a single bound to make investors richer, even when the stock market is acting the villain."

Aren't they so? Doubtful, it seems, because `performance numbers can be sharply misleading' in the absence of reporting rules. More than one in four hedge funds go out of business, say statistics; but "because many funds, especially struggling upstarts, do their business outside the public eye, the failure rate may be much higher." As a result, "Investors barely get a glimpse of the casualty rate, or their own chances of success," notes www.chicagotribune.com.

One of the `mischief prone' areas in investment management is performance reporting, conceded Kurt N. Schacht, Executive Director, CFA Centre for Financial Market Integrity, when he appeared before the US Senate Sub-Committee on Securities and Investment, on May 16 for the hearing on `the role of hedge funds in capital markets'.

He cautioned about statistical shortcomings in hedge fund performance data that were `broad-based, voluntary, private services'.

One learns from the transcript available on http://banking.senate.gov that the available data significantly overstate hedge fund performance by 100 to 600 basis points and are misleading to investors.

GIPS document

Schacht recommends the use of Global Investment Performance Standards or GIPS, "a template for investors and managers to understand the various procedures needed to calculate and verify performance," which appears to have acceptance in 30 countries.

The 59-page GIPS document on www.cfainstitute.org should be useful read for managers, though India is not in the list of 30 countries. On the Senate Committee's site, there are more than half-a-dozen other testimonies, with different perspectives about hedge funds.

Meanwhile, a May 25-dated story by Alex Akesson on www.hedgeco.net grabs attention with its headline, `India welcomes Hedge Fund Investments'.

He writes, "Last week has seen outflows from Indian and other emerging markets, and is one of the first signs that these hedge funds book profits in the best performing markets, ahead of change in macro-dynamics."

All of which make hedge funds a space worth watching by regulators closer home.