Hedge Fund ReportingHedge Funds
Hedge fund reporting functions differently than mutual fund reporting. Dissimilarities are due to their unregulated status. Hedge funds should optimally release performance and risk reports once a quarter. Funds often choose to release reports biannually, with some only releasing one report a year. Funds which release no reports at all should be concerning.
Hedge Fund Reporting: Optional Reports
Deregulation allows hedge funds to report on a fairly optional basis, which is exploited to brag about returns and hide performance issues. Even if a fund is reporting its high performance, funds are careful to hide their investment positions from others in the hedge fund industry. This involves keeping their secrets even within their reports, as funds will happily scour competitor’s return reports for performance hints. Arbitrage and other directional opportunities can be closed or countered by other market players exploiting the same chances.
While rival funds cannot be allowed to know a hedge fund’s positions, investors need reports to see their returns. They also need to see the risk profile of the fund, which requires knowing investment positions. This is directly contradictory to keeping positions secret. The solution is requiring investors to sign silencing confidentiality agreements when initially investing in the fund.
Hedge Fund Reporting: Report Contents
Once inside the fund, you may begin receiving performance reports distributed to investors. The documents will be a collection of reports containing investment positions, position values, and returns earned. This may include individual assets, derivatives, and currency positions. If it does, compare the list to your specific risk exposure needs. Are there overlaps with other investments within your portfolio? Does the fund still fill the role that triggered your initial investment? Do the same for return; ensure that the fund has adequately performed as desired, especially in relation to the risk it seems to be incurring. Risk and cost adjusted returns are far more important than the nominal returns written in the document. If general partners do not list specific positions, they often are trying to avoid giving away positions and strategy. They may alternatively be dodging conversations about poor performance within specific investment strategies.
Hedge Fund Reporting: Value at Risk
When looking at risk within the fund, remember that leveraged positions increase the actual risk taken. The risk you are shown may be lower than the real investment position. A primary indicator of risk is the “Value at Risk” statistic. Value at Risk, or VAR, indicates the risk of losing a specific amount of money over a specific amount of time. The figure will state the potential loss, chances of incurring that loss, and the amount of time the current VAR number is relevant. These numbers are not necessarily static, and you should assume if market conditions change substantially VAR will as well.
Hedge Fund Reporting: Manipulating Returns
Risk and return levels are selectable. Hedge fund managers can modify the appearance of both by carefully picking baselines and dates of reporting. There are several ways a hedge fund’s return can be manipulated during its calculation.
A fund manager may select dates that end performance ranges. By manipulating the starting and ending dates of a quarter dates they can silently boost their results and hide potential issues. If normally reporting a quarter would result in revealing investment losses, they may increase the reported range so starting and ending prices are closer, hiding the decrease in value. They can also select a date with a low price to begin a quarter, and the highest possible date to end a quarter, to boost the appearance of profitable return. Ensure managers are using the same investment date ranges and not adjusting period lengths to boost appearances and hide mistakes.
Managers can also manipulate investment assets and investment values to adjust performance appearances. By inconsistently switching the baseline and current valuation models used to value assets, they can boost the appearance of results, even if they aren’t really there. They have higher leeway with certain asset values than others, such as illiquid assets where current value can be estimated using several potential models. In the case of risk adjusted returns, managers can sell risky assets before creating asset lists, adjusting the fund’s risk level before calculating any indicator of risk adjusted performance.
These techniques are used to hide a fund manager’s lack of investment skill. Successful general partners will not have to manipulate reported returns. Be suspicious of anyone you believe may be changing standards to hide losses or boost earnings within their reports.
One way to avoid manipulated reports is by ensuring the fund is regularly audited by a certified accounting firm. Ensure this firm has no other conflicts of interest with the fund. Be wary of hedge funds which are either unaudited or audited by uncertified accountants. You should avoid funds audited by accounting firms with a clear conflict of interest. The most blatant example is hedge funds with a partial or total ownership of the auditor or the auditor’s parent company. Personal relationships, such as family members, romantic partners, or longtime associates may also be conflicts of interest. If you believe it is likely these issues are occurring, exit the fund. You do not need to be invested with people who lie to you, especially if they are compromising the professional standards of employees to accomplish their lies.
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