Hedge Funds Try To Cope ; post madoff revelations and Investor Demand for Transparency

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The Future Of Financial Markets

Fund managers might take solace that they beat the Standard & Poor's 500, but comparing a multistrategy index like that to the S&P doesn't make a lot of sense.

The hedge fund industry has already started to respond to the damages wrought by Madoff, says Stephen Roseman, the founder of New York-based hedge fund Thesis Capital. He points to greater transparency as one way the often opaque hedge fund industry will react.

Specifically, he says managed accounts are becoming more popular within his industry already. These allow hedge funds to manage money while still allowing the investor to decide where the money ultimately resides at night. "They can see what trades were made and across strategies," Roseman said. In other words, black boxes, which promise results without disclosing the secret sauce that makes it happen, are out.

However, Michael Ervolini, the chief executive of Cabot Research, adds that even managed accounts are not problem free. "The kind of transparency Stephen is talking about does not tell you what the risk is," he says, "it just tells you what the hell happened at the end of the day."

In other words, even in a revised hedge fund world it still makes sense to diversify your risk in several different places. Because transparency and blind faith are simply opposite ends of the same equation.
Hedge Funds In 2009

Roseman: From an industry point of view, there is no doubt we are moving to a world of much greater transparency. It is something investors have been getting closer to in any case; this will only accelerate that process. It's not going to do anything to temper the enthusiasm for transparency.

In the shorter term it might have a profound impact on the industry. There are a lot of people for whom this will temper their enthusiasm for being in the market in general. Whether it's because they're invested with any of the great mutual fund mangers down 50-60%, or they invested with a hedge fund whose strategy went awry. Or they invested with a private equity firm that is over-levered, or LBOs that have gone bust.

The outcome really doesn't matter; it's the emotional component. We want the money back in our pocket, we want to live with it, touch it and sleep with it for a while.

And once the crisis, once the headlines pass, people will be able to start thinking about allocating capital again. Because one thing that's true is that nobody is going to accomplish what they need to do by owning Treasuries at negative yields.

I understand the visceral need for people to touch their money again. Because at the end of the day equities are how you generate the greatest return. I make the comment about equities because that's where most people have most of their exposure.

By the way credit markets can be in as much disarray as equity markets. But certainly, for most institutional investors, equities represent the biggest (exposure.)

When people think about the markets and how their money is doing that is the go to, even though people are invested in credit and fixed income. There's no doubt people are worried about the safety of their money, and they want to see it.