Tag Archives: Healey Hedge Fund

Regulations on hedge funds in the United States

18 Jan

While the fact is that hedge funds are considered “unregulated,” there are some major stipulations to that claim. No investment is legally allowed to be unregulated, and so the term unregulated may give people the wrong impression. Regulation is necessary for hedge funds, although in practice they are quite a bit different from other investments. In terms of regulations regarding hedge funds within the United States, there are several things potential investors (and the average person) should know about.

The most direct way that the US has found to regulate hedge funds is by regulating the practices of financial advisers (the money managers). While it is true that hedge funds are considered to be private investments, and that money managers have limited transparency when engaging with the investments, they must still adhere to any regulations set down. This regulation is to protect against illegal activity and fraud, and to protect investors who trust their money to another party. The biggest issue with money managers is compliance with mandatory record keeping. Money managers/advisers with over one hundred and fifty million dollars in managed assets are required to register as such. This is one way of “keeping track” of hedge fund investors and their managers. Because of the privately owned status of hedge funds, they are exempt from reporting with SEC (US Securities and Exchange Commission); although in some situations there are exceptions to that rule of exemption. One such exception is the fact that hedge funds with equity securities with more than four hundred and ninety-nine owners/investors have to report to SEC.

Under the Investment Company Act of 1940, hedge funds are limited to one hundred or fewer investors. Another requirement under the Investment Company Act of 1940 (which was what allowed hedge funds to be exempt from SEC in the first place) stipulates that there is certain criteria that potential investors must meet in order to be able to invest in the first place. If investors can jump through those regulatory hoops and become a “qualified purchaser,” the hedge fund investment can move forward and take place. Individuals who meet “qualified purchaser” status would have to have at least five million dollars in investment assets. Companies, meanwhile, would need twenty five million dollars in investment assets. That is the very beginning of the criteria for investor qualification, and much of it specifically varies by state.

Other regulations to keep in mind regarding hedge funds in the United States would be that hedge funds cannot sell their securities publicly. Hedge fund shares are not registered. Hedge fund managers that own more than five percent of any equity securities are subject to public disclosure as well. These are just some of the additional regulatory stipulations and scenarios that investors and managers must comply with. All of this information is the “tip of the iceberg” when it comes to hedge fund regulation inside of the United States. As mentioned earlier, specific regulations may vary by state, and this complicates an already confusing situation.

Hedge fund indices

28 Dec

Like many other types of investments, hedge funds have indices that track the industry. There are some differences between hedge fund indices and more traditional investment indices, as hedge funds are considered private investments, and more than that, they are mostly all illiquid. This poses some issues with the reliability indices; how comprehensive, and thus satisfactory, are they, really? This is part of why several different methods of hedge fund indexing have been created over the years.

Regardless of whether or not hedge fund indices are fully satisfactory, there is no question that they exist, and that people use them. There are generally three types of hedge fund indices, and these include:

  • Non-investable indices – Using a hedge fund database from which to measure performance, non-investable indices are the oldest type of hedge fund indices used. The databases use weighted mean, medium, and mean in order to measure performance. No one database will represent all funds, which means that no one database is the same as another; every single performance result will be different. This is an issue that some have with the reliability of non-investable indices. Another issue that some have with them is that they are subject to a lot of bias. For one, database reporting is voluntary, which in some cases may lead to self-selection bias. Additionally, hedge funds may come and go (fail and succeed, if you will) annually, which changes the database selection significantly every year.
  • Investable indices – the main goal of an investable index is to eradicate some of the bias and issues raised with using a non-investable index. The main method it does this is by making the index return available to all shareholders. In an investable index, the index provider/manager will select certain funds to develop something somewhat like a “fund of hedge funds” portfolio. The investments created by the index provider must be accepted by any hedge funds, in order to be properly investable.
  • Hedge fund replication – this is more of a statistical look at how hedge funds have performed, analyzing past returns in order to make models of how hedge funds will perform under various circumstances with different assets. The model(s) can be used to make an actual portfolio of assets, and thus makes the index investable. Of the three types of hedge fund indices mentioned here, hedge fund replication is probably the newest. One of the pitfalls that goes along with this index form being so new is that there is very little history or data to support its usefulness in practice – especially when one considers the private, rarely disclosed nature of hedge funds themselves.

This is essentially the beginning of what hedge fund indices entail. They are meant to give investors – and the financial market as a whole – a view of what average returns on hedge funds are, and how they change throughout time. Even though there is some question as to the reliability of hedge fund indices, given that most of the data found within is self-disclosed and therefore very limited, they are popular and continue to grow.

Regulations for hedge funds in other countries besides the U.S.?

15 Dec

Regulation of hedge funds does differ when taken outside of the boundaries of the United States. However, much of the regulation on hedge funds throughout the world does resemble the regulation in the US. In Europe, for example, the primary method is to regulate the financial advisors/managers of the funds. The managers are required to register with the FSA (the Financial Services Authority). Within the European Union, there have been some differences with regulation between different countries, but the hard and fast rule is that EU fund managers are required to register.

Recently, something called the Directive on Alternative Investment Fund Managers, or AIFMD, was passed by the EU to better monitor the activities of hedge fund managers. Countries within the EU are required to adopt the practices of AIFMD by 2013. It is quite an undertaking for every hedge fund manager within the European Countries to comply with the regulations in AIFMD, but AIFMD has made certain allowances to make the transition easier. For example, they have introduced a sort of passport that enables any hedge funds authorized in a country in the EU to operate throughout the entire EU.

Obviously Europe is not the only place aside from the United States that participates in hedge fund activities. An incredibly popular option for those abroad, and even for a portion of American citizens, is to run the hedge funds through offshore locations. This includes Bermuda, the British Islands, Dublin, the Cayman Islands, and many more locations. Any hedge fund that is run through an offshore location has to comply with the individual regulations there. Offshore hedge funds are quite different from other types of hedge funds; one example of this difference is the fact that the funds are valued as net asset value (NAV), not as account balances as with domestic funds.

In South Africa, registration with and approval from the Financial Services Board (FSB) is required for hedge fund managers. Also in South Africa, much emphasis is placed on local investment rather than international. In Singapore, hedge funds are less regulated and have fewer licensing requirements than other Asian hedge fund “hot spots,” such as Hong Kong. Singapore is a popular hedge fund location for this reason.

Recently, the Dodd-Frank Act was passed in the United States. This act has wide reaching implications and may change the nature of hedge funds throughout the world. Those international hedge funds that have more than twenty-five million dollars with fifteen or more American managers or investors must register with SEC. Managers who are registered with SEC are also required to file and keep information about managed assets up to date with the SEC as well.

This is only the beginning of overseas regulation for hedge funds. However, it illustrates that there is still a focus on regulating investment managers rather than the investments themselves. Hedge funds are popular globally, and there is a good amount of cross over investment from countries with financial hubs. Some seek to take advantage of the opportunities presented by offshore accounts, but new regulation may be changing some of that activity.

Controversy and debates about hedge fund

2 Dec

There are several debates and controversies on the subject of hedge funds. A good deal of the debate has to do with the fact that there is supposedly systemic risk when dealing with hedge funds. Also, a good deal of attention is paid to the fact that there is very little transparency required with hedge funds, as they are considered private investments, and have limited regulation compared to other types of investments.

Critics of hedge funds have claimed that the nature of these high risk investments could lead to a domino effect in the financial sector with catastrophic results. Systemic risk refers to the collapse of the entire financial system, and so it may be difficult for some to picture one failed hedge fund or failed hedge fund company bringing the entire system down. However, people who feel that – if such a failure should happen, and it should be noted that failure has happened on scales both big and small – a major failure could occur with one hedge fund, and be seen in hedge funds that are similar. Many pro-hedge fund people debate this claim of systemic risk, because failure has already occurred in many hedge funds, and the result was that the financial system was nowhere near systemic failure. When a hedge fund does fail, they are typically leveraged low and the market as a whole can weather the failure fairly easily. In fact, dozens of hedge funds failed during the financial crisis – and there was still not systemic failure.

The other major issue that is up for debate is transparency. The lack of disclosure that is required regarding hedge funds is deeply troubling to some people, who argue that this atmosphere of secrecy can perpetuate fraud. In many cases, the investors themselves have very limited information on what the hedge fund managers are actually doing. An example of issues with transparency would be that many American hedge funds do not rely on third parties to perform crucial tasks, such as administration or acting as custodian of assets, and this has been shown to lead to conflict of interest, and in some cases even fraud. There have been several high profile arrests made of people who have engaged in fraudulent behaviors or schemes with regards to running hedge funds.

Another issue regarding hedge funds is the fact that it is extremely difficult to track performance statistics. Between the fact that the majority of hedge funds were not required to submit performance findings, and the fact that there is a restriction against public advertisement and offerings (leading to a reticence or outright refusal of fund managers to willingly put the performance information out to the public), it is incredibly difficult to comprehensively study how hedge funds perform on average. Individual funds can be studied, but many remain a relative mystery.

These are just some of the controversies and debates surrounding hedge funds. Hedge funds are a subject of some scrutiny after the financial crisis of recent years. The SEC, for example, is scrutinizing the possibility of insider trading within hedge funds; it remains to be seen, but there is always a chance that regulation will be strengthened for hedge funds.