Hedge funds are increasingly focusing on greater risk management and transparency to meet the needs of investors and fund managers, according to a new study from the Managed Funds Association (MFA), BNY Mellon and HedgeMark.
The study, Risk Roadmap: Hedge Funds and Investors Evolving Approach to Risk, found that hedge funds project that five years from now 41% of investor reporting will be published daily or weekly, up from 22% today and just 12% in 2007. More than 91% of hedge funds surveyed said they use third-party administration in a risk management capacity.
Investors are increasingly taking a trust and verify approach to a hedge funds reported risks and exposures, says Orla Nallen, managing director of Alternative Investment Services at BNY Mellon. As a result, hedge fund managers have augmented their reliance on independent, third-party administrators and will continue to do so. More fund managers are turning to third-party administrators not only for operational risk mitigation and transparency support, but also for services that help them expand into new markets and satisfy regional regulatory reporting, such as UCITS exposure and Form PF.
Part of the motivation is the result of new international regulations, including Basel III, the Dodd-Frank Act and the European Market Infrastructure Regulation (EMIR), the firms say, which has highlighted risk management practices. Hedge funds today are increasingly more willing to tell their story in plain language with a keen focus on sharing and explaining their risk approach, according to the study.
Other findings in the study included that 79% of hedge funds separate risk manager and fund manager functions to ensure independent oversight; 55% considered liquidity risk of the highest importance; 60% of large hedge fund managers have a dedicated risk management function; and 84% of hedge funds use off-the-shelf risk analytics in their portfolio management or trading systems.
Risk has always been central to the investment process, but we are definitely seeing an increased focus on risk from both hedge fund managers and investors, says Andrew Lapkin, president of HedgeMark. For managers, its about protecting against unexpected losses and ensuring that the risks being taken are properly rewarded. Investors are particularly focused on many of the non-market risks including fraud, counter-party, liquidity and reputational risk concerns that have been at the forefront of investors move to managed account solutions, only now we are seeing a greater focus on solutions provided by the highest rated providers and fund administrators.
The study also identified 14 types of risk that confront hedge fund managers and investors, ranging from liquidity, volatility and credit risks to currency, commodity and meta risk, which captures all the qualitative risks that cant be easily measured, such as human and organizational behavior or moral hazard.
Todays hedge funds are operating in a dramatically different environment than five or ten years ago, dedicating more resources to risk management and communicating more frequently with investors, says Richard Baker, president and CEO of the Managed Funds Association. Improvements to internal governance, independent transparency, quality and frequency of reporting can go a long way to strengthen the partnership between investors and fund managers. As the industry continues to evolve, we will see even more attention given to risk management, helping managers and allocators work together to navigate global markets.