(April-2003) APRA raises alarm on hedge funds

The Australian Prudential Regulation Authority (APRA) will be looking to see whether super fund trustees have performed adequate and appropriate due diligence investigations before making investments in hedge funds.

APRA senior manager Louis Serret says: “We will be examining investments in hedge funds and the processes used to assess these when we visit super funds. We have already started doing this and we will continue until we are satisfied that the majority of funds are adequately addressing the concerns [APRA has about these funds].”

Serret adds that APRA is “not 100 per cent” satisfied with what it has already seen. “There is room for improvement,” he says, adding: “[In some cases], we have not seen the actual paperwork or consideration that we would have expected to have seen before an investment was made in hedge funds.”

Last month, APRA warned the superannuation industry of the many concerns it has about hedge funds, a growing investment route for super funds seeking to boost returns in a poor equity investment environment.

Among these are that hedge funds rely heavily on a single strategy, with broad delegations for the use of gearing and derivatives, and on a single individual to execute the investment management process. In addition, they are characterised by relatively short trading history and an absolute return rather than a benchmark return.

Serret says: “Hedge funds are not traditional investments and trustees should not use traditional investment criteria to assess them… You cannot take for granted the things that you normally do when a larger fund manager comes and sits down in front of you.

“It’s important that trustees understand the product and if they don’t, then they really should stay clear of it… We don’t want trustees to short circuit the due diligence process because it’s too hard. They should rather err on the side of caution.”

Serret adds that hedge funds use many strategies and some are more complex than others. There are also wide disparities in the quality of reporting and disclosure of hedge funds.

APRA senior analyst Chris Wilson notes that traditional fund managers have mandates that clearly outline what they have to do and help avoid style drift. With hedge funds, however, there is a risk of style drift. Traditional fund managers are compared against benchmarks, but hedge funds have none, he says.

Several hedge fund managers, however, have criticised the APRA’s warnings.

Speaking at the hedge.fundsWORLD conference in Sydney last month, the Alternative Investment Management Association’s (AIMA) global chairman Hans-Willem van Tuyll said APRA’s remarks were damaging to the industry in Australia, which employed a pool of talented and intelligent individuals.

Van Tuyll said APRA’s comments implied start-up hedge funds collapsed at a greater rate than new businesses in general, but this was not the case. The incidence of hedge funds going out of business was much lower than businesses in general.

But Hedge Funds of Australia managing director Spencer Young says the questions raised by APRA are no more than questions trustees should be raising anyway throughout their due diligence undertakings on a manager.

He concurs with APRA’s view on single strategy hedge funds, saying that all but the most sophisticated investor should stay away from these funds. Overall, however, he says APRA’s claims are “wildly generalistic” and “headline grabbing”.

Local chair of AIMA and head of hedge funds at Colonial First State, Damien Hatfield, welcomes APRA’s focus on hedge funds but is disappointed his industry and the superannuation industry were not consulted on the matter.