Tue, 01/03/2005 - 06:17
Edhec has released the results of its wide-ranging European consultation on funds of hedge funds reporting.
The survey, which brings together the opinions of 98 institutional investors and fund managers, was based on a series of recommendations proposed by Edhec with regard to the academic state-of-the-art on risk measurement in the alternative universe. And despite somewhat conflicting goals, the results, which were presented to a panel of journalists in London last week, reveal that investors and fund managers - except for slight discrepancies - globally agree on the definition of relevant information, and as a result on the content of the reports of tomorrow.
According to the results, investors and fund managers appear to be favourable towards monthly frequency and require a report with three major levels of aggregation, namely at the strategy group, strategy and fund levels. In an attempt to mitigate the risk of a data overkill effect, Edhec suggest fitting the quantity of information to the aggregation level, ie detailed information at the strategy group level and thoroughly selected information at the fund level.
As highlighted in a previous study published by Edhec in 2003 (the Edhec European Alternative Multi-management Practices Survey), the practices of a large majority of European multi-managers are heavily influenced by those observed in the traditional world. Another encouraging result of the Edhec Funds of Hedge Funds Survey is that market participants are progressively adapting their tools to the specific features of hedge funds. They agree that funds of hedge funds reports should:
1 Properly inform investors on the level of risk: investors should be provided with indicators covering the whole spectrum of risk, namely normal risk (eg volatility), loss risk (e.g. maximum draw down) and extreme risks (eg modified Value-at-Risk). Risk-adjusted performance indicators should also span these different definitions of risk so that investors can be provided with relevant information, whatever their risk preferences.
As a matter of fact, 46 per cent of fund managers and 74 per cent of investors consider that a style value-at-risk should be disclosed to investors. Some 37 per cent of fund managers and 48 per cent of investors favour disclosure of a modified value-at-risk. In the study published by Edhec in 2003, only 20 per cent of fund managers were including a value-at-risk estimation in their reports.
In the same vein, while the Sharpe ratio remains a must for 77 per cent of fund managers and 79 per cent of investors, 57 per cent of fund managers and 48 per cent of investors now require the Omega ratio too. For comparison purposes, in the study published by Edhec in 2003, only 4 per cent of fund managers considered the latter ratio as important to very important.
2 Properly inform investors as to the nature of risk: investors should be provided with information on the key determinants driving fund of hedge fund performance (eg volatility risk, liquidity risk, credit risk, etc), so that they can gain a better understanding of the fund's risk profile, and as a result ease its integration into their global allocation process. This can be done with static/dynamic style and factor analysis.
According to the study published by Edhec in 2003, only 47 per cent of fund managers were integrating a style analysis in their activity reports. Some 67 per cent of fund managers and 84 per cent of investors now consider that both static and dynamic style analysis should be found in fund of hedge fund reports. For factor analysis, these figures are 56 per cent and 85 per cent respectively, while 73 per cent of fund managers and 90 per cent of investors would also like to find unconditional/conditional correlations with risk factors.
This convergence between the intentions of market participants and academic recommendations indicates that the process of industrialisation in the alternative arena will shortly begin to bear fruit. In particular, it suggests that fund managers plan to increase their efforts to improve the quality of their reports in an attempt to live up to increasingly demanding investor expectations. It is definitely an encouraging sign for investors who are still reluctant to dip their toe into the ocean of hedge fund strategies because of deficient investor information.
It will be very interesting to see whether the good intentions are followed by concrete changes in practices. This is what we will find out in the next Edhec Funds of Hedge Funds Reporting Survey, which is planned for the end of 2006.
The full version of the Edhec Funds of Hedge Funds Reporting Survey is available in PDF format from the Edhec Risk and Asset Management Research Centre.
Background notes: Established in 1906 and accredited not only by the "Conférence des Grandes Ecoles françaises" but also by the AACSB, Equis and AMBA, Edhec has been one of the top business schools in Europe for several years.
Edhec's financial research laboratory, the Edhec Risk and Asset Management Research Centre (www.edhec-risk.com), with its 28 professors, engineers and research associates, carries out major research programmes in the areas of asset allocation and risk management in both the traditional and alternative investment universes.
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