AIMA issues Sound Practices Guide for funds of funds

Date: Wednesday, May 6, 2009
Author: Bill McIntosh, The Hedge Fund Journal

After a year of work involving key funds of hedge funds executives, solicitors and administrators, the Alternative Investment Management Association has published The Guide to Sound Practices for Funds of Hedge Funds Managers.

When AIMA and the fund of funds executives began work on the guide one year ago, few could foresee the liquidity crisis that would come to dominate the latter months of 2008. Then, just as the worst seemed to have passed, the Madoff fraud rocked a good number of funds of hedge funds. With the benefit of hindsight, it’s clear that the decision to prepare the guide was an inspired one and showed real commitment to pushing the industry forward.

“We wanted to make sure the guide was thorough and could apply in multiple jurisdictions,” says Andrew Baker, AIMA’s CEO. “That was a big part of the challenge. Investor preferences, practices and regulators are all substantially different.”

At the same time, the Steering Group sought to avoid being overly prescriptive. Its members were well aware that a ‘one size fits all’ approach wouldn’t be appropriate for an industry that is practically defined by its resistance to easy classifications.

The guide marks a new chapter in AIMA’s publishing programme. It builds on a 2005 sound practices guide for European hedge fund mangers which has since been revised. But the approach and the principles underpinning the new guide are rather different.

“We wanted to demarcate the two,” Baker says. “We didn’t see it as our role to say what underlying hedge fund managers should be doing. The structure is the same as it covers similar ground such as the investment process, good governance, infrastructure, administration and fund structures. In every case, however, there are significant differences that can arise between funds of funds and the next level down.”

The timing of the guide’s publication is certainly appropriate. There is wide spread acceptance among both investors and managers that a number of practices must be altered and improved in order for new capital allocations to occur.

“Cast your mind back a year ago,” Baker says. “There hadn’t been the round of liquidations go through the market place. But there was a sense that gating and illiquidity could become an issue. Little did we know the tidal wave was about to break.”

Attaining Best Practice
The guide is meant to help fund of hedge funds managers endeavour to reach best practice. The road to this is necessarily a different one than that laid out by the Hedge Fund Standards Board for single fund managers.

“You should see them separately,” says Baker of the two guides. “We didn’t want to lecture one group of members with this guide. Our role here is to assist the process of disclosure.”

Baker commends the funds of funds who committed to the process at a time when the industry was relatively becalmed. Now, of course, the setting is very different.

“Everyone who went into this knew the implications,” says Baker. “They knew that when the guidelines were published they would have to face the scrutiny of investors. But they knew it was in their interests and would give leadership to the rest of the sector.”

Particular attention went into the investment process, including the key ingredients of due diligence. The section on administration involves detailed discussion of managing not only cash balances, but borrowings, hedging and the potential for mis-matches between the liquidity of the underlying portfolios and the investor base.

“It is crucial to be able to see the whole picture,” Baker says, discussing the importance of matching liquidity and redemption terms. “What were thought to be perfect matches became mis-matched through no fault of one’s own.”

The prescription to this is straight forward. “There needs to be more modelling on the liquidity profile of the investors,” he says. “How will investors in, for example, different countries or advised by different consultants respond to different events in the redemption cycle?”

On due diligence, the guide distinguishes between the point of first allocation and ongoing monitoring. It was judged that there needs to be more transparency about this at the funds of funds level.

“There needs to be a better audit to ensure marketing claims are actually met,” Baker says. “The stronger this is the better you will get along with underlying investors.” For institutional investors, which evidence shows are continuing to allocate to the sector, the guide provides a timely reminder of many of their more pressing concerns.

“A number of funds of funds have provided good transparency to investors and have performed pretty well,” Baker says. “Those guys are keeping a low profile, but they are out there. There are plenty of lessons to be learned from recent incidents and we hope to have encapsulated them in this document.”

The Steering Group members behind the guide are:

Patrick Fenal (Chair)
Unigestion

Christopher Fawcett

Fauchier Partners LLP

Paul Dunning

Financial Risk Management Limited

Christian Bartholin

HDF Finance

Sean Simon

Ivy Asset Management LLC

Pierre-Yves Moix

Man Investments AG

Stephen Oxley

Pacific Alternative Asset Management Company

Ronnie Wu

Penjing Asset Management

Steven Whittaker

Simmons & Simmons

Andrew Baker

AIMA

AIMA expresses its gratitude to all Steering Group members for their unstinting commitment, in particular, Gilles du Fretay, President and Christian Bartholin, Directeur Général Délégué of HDF Finance who conceived the original idea for the guide. AIMA also expresses its gratitude to Patrick Fenal and his team of colleagues who chaired the Group.

Other Contributors included:

Fortis Prime Fund Solutions (UK)
KPMG LLP
Managed Funds Association
PricewaterhouseCoopers

We will be publishing extracts from the guide in our May 09 issue.

The guide itself is available to members on request to AIMA. For details contact AIMA at www.aima.org.