Moody’s Investors Service has completed its first public Operations Quality (OQ) rating of a hedge fund. The investment manager of the fund is Sorin Capital Management, LLC.
Sorin Capital Management, LLC uses an investment strategy which can be broadly classified as fixed income relative value with a primary focus on commercial real estate debt. The CEO and chief investment officer is Jim Higgins, who has spent a large part of his career trading commercial mortgage-backed securities. New York City-based Sorin Capital Management, LLC manages more than $300 million of investor capital and has been in existence for approximately two years.
Moody’s OQ ratings address aspects of a hedge fund’s operations, both internal and external. Moody’s determines the OQ rating by evaluating the following areas: valuation process; service providers; accounting controls; regulatory compliance; risk reporting and control; legal and financial structure; human resources; and any other issues specific to the fund being rated. The rating scale ranges from OQ1 to OQ5; OQ1 is excellent and OQ5 is poor.
This first public rating on an individual hedge fund’s risk is a closely watched move that could shed light on an industry which manages more than $1 trillion in assets and has traditionally avoided outside scrutiny.
The rating is unusual for the ratings service. Moody’s, a subsidiary of Moody’s Corp., and its chief competitor, Standard & Poor’s, a unit of McGraw-Hill Cos., generally rate the quality of a company’s debt based on the perceived likelihood of a default. Others rate the track records of mutual funds based on returns. However Moody’s is rating neither the hedge fund’s debt nor its return. It is rating the “operational risk” of Sorin Capital, i.e. how well Sorin runs its business, from its back-office systems to the controls it has in place to avoid experiencing sudden losses. Moody’s also conducts background checks on managers. These issues are of concern to investors in the wake of alleged frauds at firms such as Bayou Management LLC and Wood River Capital Management LLC.
“There’s definitely a strong desire from investors to understand and assess our operational quality,” says Mr. Higgins, chief executive of Sorin Capital. He decided to obtain a rating after being approached by Moody’s in April. Mr. Higgins says that some sensitive information came up during the ratings company’s review, which took place over a few months and involved multiple meetings and conference calls. But he believes Moody’s will be discrete about handling this information.
Moody’s assigned a rating of OQ1-minus to Sorin’s fund, one notch below its highest “operational quality” rating that has a scale of 1 to 5. Moody’s new ratings can be viewed on its Web site by “accredited” investors, generally defined as those with a net worth of at least $1 million or at least $200,000 in annual income. Gary Witt, a Moody’s managing director, says that the firm is in talks with a few other hedge funds and expects to publish another public rating soon. To persuade more funds to be rated, Moody’s has been offering what it calls “indicative” ratings in which fund managers can get a preview of their rating before deciding whether to proceed. Mr. Witt notes that this approach would allow funds with less-favorable reviews to avoid public scrutiny. That means there might not be many funds with low public ratings in the near future, “unless this becomes something of a market standard,” he says.