Hedge funds and Private Equity - PES

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rules on the disclosure of total charges to retail investors should be agreed to allow for objective
and accurate comparison of charges – especially where fund of hedge funds are involved.
Illustrations and projections should be provided on a consistent basis to allow investors to
compare the offerings of different fund managers – that is, funds with a similar investment
strategy should be required to use the same projected investment growth rates net of actual
total expenses and charges;
the EC should ensure that the content and presentation of risk warnings in any marketing or
promotional material should be clear, fair and conform to minimum standards.
Safeguarding pension funds
As far as investor protection is concerned, the focus should be on information for institutional
investors. They should be able to assess and compare financial returns and risks of the different
types of management. Transparency requires more frequent disclosure of returns and risk characteristics,
the storage of those data in a public database available to all investors, the
computation of hedge fund indices and the disclosure of all management costs and fees charged
on their clients. Information should be available about the appointment of a custodian bank, and
common and effective rules relating to market pricing, public communication and disclosure of
attained financial returns.
Funds that are eligible for marketing to retail investors should conform to a number of safeguards
including:
the need for an independent depositary;
retail investors should have access to alternative investments only under certain conditions –
for example as part of a ‘fund of hedge funds’ or within a portfolio of conventional assets;
even then restrictions should apply with regards to diversification, limits on exposure, and
liquidity criteria.
Supervision and management of systemic risks
Financial authorities should ask prime brokers for a periodic full disclosure of the exposure
(fund by fund and then of the whole client base) to different categories of financial risks.
To assess the credit risk of hedge funds an international credit register should track all counterparties’
exposure on individual hedge funds.
A prudent ‘rule of thumb’ used in the hedge fund world is that no more than 2 per cent of assets
should be risked on any one uncorrelated ‘bet’ (that is, speculative investment). Such limitation
would help limit the size of bets taken by hedge funds, and thus the danger to the stability of the
system, (i) by increasing the stability of individual funds, and (ii) by putting a brake on the extent
to which ‘herding behaviour’ can occur.
The EC should also create a framework to allow alternative investment funds to be classified
and rated according to investment strategy and risk. This would allow for improved evaluation of
comparative risk and return, better communication to investors, and promote more efficient
competition as performance fees could be challenged.
Prime brokers should have the duty to limit credit line extension to any single fund whose potential
future credit exposure appears excessive.