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9194
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7291
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Aberdeen Asset Management present a roundtable discussion on Hedge Funds with Jonathan Stapleton, Professional Pensions (Chair); Daniel Summerfield: Co-Head of Responsible Investment, USS Investment Management Ltd; Neil Dolby: Head of Alternative Operations, Aberdeen Asset Management and Paul Govier: Head of Investment Funds Group, Maples and Calder.
Bookmarks:
0|Hedge Funds Roundtable
72|Structure
253|Lessons being learnt
568|Good practice
846|Governance
1121|Standards
1289|Industry placement
1546|Outlook
Duration:
00:22:00
Recorded Date:
17 April 2013
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Transcript:
Presenter: Welcome to the Aberdeen Asset Management Hedge Fund Roundtable. My name is Jonathan Stapleton, editor of professional pensions. Hedge funds have become a popular investment tool among investors in their search for a greater yield coupled with their ability to increase diversification. Yet while hedge funds can offer schemes and other institutional investors a set of investment strategies that offer proven diversification benefits the right sort of governance structure needs to be in place to mitigate risk.
This debate, we’ll discuss these governance structures, look at what investors are looking for in hedge fund governance, the lessons that are being learned from the past and how the industry is placed for the future. Joining me to discuss these issues are Daniel Summerfield, Co-head of Responsible Investment at USS Investment Management; Neil Dolby, Head of Alternative Operations at Aberdeen Asset Management; and Paul Govier, Head of the Investment Funds Group at Maples & Calder.
Gentlemen looking at the first issue, Neil, what does a hedge fund structure look like? What’s the typical governance overview?
Neil Dolby: Okay. We all understand when making an investment we want to exposure to the investment manager, and we’ve done due diligence around that process, but I think we need to understand that what we’re actually investing in is a fund, which is a legal structure. And that legal structure can come in many forms, but a typical structure is a Cayman corporate structure, and that will have as similar with any other corporate structure a board of directors, and ultimately that board of directors is responsible to us as shareholders to oversee and make appropriate service provider appointments.
Now, typically, when we talk about service providers, people understand that to mean the administrator, the custodian, the broker etc., but it’s also true, and that the investment manager is also a service provider, clearly it’s the key service provider, because one’s trying to obtain exposure to that particular investment strategy and investment policy, but nevertheless it’s an important thing. So an ideal board structure should be composed in our view of a board of around five people with two or three independent directors who have knowledge of the investment strategy and also are capable of asking questions to the investment manager and also other service providers so that they can actually execute their fiduciary responsibilities on behalf of shareholders.
Paul Govier: Yeah. I mean the formal structure that’s typical taking Cayman as the most common domicile is either the limited partnership or the unit trust, so the three types of structures that investors will encounter, and the selection of the structure really is driven by investor preference and their own domestic requirements more often than not. So it’s against that background that the structure is selected. The US model tends to be for domestic US investors a limited partnership with a corporate general partner, again based in Cayman, potentially in Delaware. If you’re in Asia for example you may find the unit trust is a more common form of vehicle.
In the round leaving aside the nuances of law, which I know people probably don’t want me to bore them with on this panel, but the principles that we discussed in relation to the sort of vanilla corporate structure, the principles of governance should apply to the other structures. There were technical differences in how they relate, but the principles are the same, but there should be a real documented, substantial set of governance principles that are effectively enforced by whoever that vehicle is run by, whether it’s a trustee, whether it’s a GP, whether it has its own board or whether it’s in fact as we’re looking at here the board of directors of a corporate fund.
Presenter: On looking at the lessons I mean we’ve got to this point in governance what are the lessons that are being learned from the past to actually get to this point, you know, what are the key regulatory developments both in I know there’ve been some in Ireland and in the Caymans with regards to this. I mean how do we get to where we are today?
Paul Govier: Yeah I mean it’s probably worth having a little sort of potted history of sort of the evolution of the hedge fund. You know, hedge funds very much originated as very talented managers leaving large institutions and sort of establishing almost on a cottage industry basis a small business managing money, and at the risk of being slightly glib it was a case of friends and family throwing them some money and saying get on with it, let me know how it turns out. And from there we’ve seen the industry evolve so that these managers themselves are now becoming much more like the very institutions they left, they’re managing huge amounts of money and they’re managing it on behalf of sophisticated investors, increasingly so.
So we’ve seen a shift and evolution in the industry away from a sort of casual if you like approach to corporate governance, an approach based on sort of familiarity and personal trust, to one of a true arm’s length commercial relationship, and I think that was happening pre-crisis, but the crisis brought that into sharp focus. And while we look at the Cayman model and we think it held up very well, if you look at the amounts of litigation or in fact the lack of litigation around corporate governance in Cayman, we think that’s reassuring to see that the model itself wasn’t broken, but there were cases and there were instances where investors identify ways in which things could be improved. And I think it’s part of the sort of growing pains of the industry and I think as a result of that what’s happened in Cayman, in Ireland, in other jurisdictions is that we see an increased focus by investors, but also by regulators on how funds are governed, what this fundamental process of oversight should involve.
And so we now see for example in the Cayman Islands there’s been recent case law in the Weavering judgement, the leading decision on how fiduciary duty should be applied specifically in the context of a hedge fund, and some very helpful comments from the presiding judge in relation to what would be expected of a good fund board, and in turn the monetary authority, the regulator in Cayman engaging in an extensive consultation process with industry, not just managers, but investors as well and all the relevant stakeholders to understand ways in which the governance structure, the regulatory framework in Cayman can be enhanced. Taking the principles based approach that it’s always been based on the adopted common law approach taken from England, but enhancing that through regulation. And I know USS and Daniel have been very involved in that process, so perhaps I’ll throw to him at that point.
Presenter: Daniel yeah so on that point I mean USS has been a pioneer in terms of improving hedge fund governance over many years, where do you see the lessons learned from the past to getting to where we are today?
Daniel Summerfield: Well I agree with my co-panellist Paul and Neil; I think this has been a journey that hedge funds have been on over the last few years. We have the advantage – USS – of going into hedge funds post-financial crisis, so we can see whether bodies have been hidden if you like and lessons that have been learned during the process. I think it’s analogist with where listed equities were perhaps twenty years ago where one had boards of directors overseeing the listed equities, but actually their role and responsibilities were not perhaps as clear defined as they should have been.
They’re there in terms of structure, but in terms of what they were there to undertake and what they were there to oversee wasn’t particularly clear either to investors, to the managers or to the directors themselves. And therefore we got ourselves into a situation I think where perhaps a business model was created, which allowed for certain directors to accumulate a significant number of directorships and not necessarily oversee the manager in the way that some investors would like and discharge their fiduciary responsibilities in a way that they should do.
So therefore I agree with Paul that we’ve now got to a stage I think where there has been significant amounts of progress in terms firstly of investors starting to take these issues into consideration when carrying out their due diligence of potential hedge funds, and also the monetary authority in Cayman, the Cayman Islands Monetary Authority also beginning to look at this in much more of an informed and detailed way than perhaps they have done to date. And certainly we welcome the proposals that have been put forward by the Regulator in Cayman. We think that what has been put forward is striking the right balance between prescriptive measures but keeping the principles based approach in place.
Presenter: Can you just sum up some of those measures? It might help give our audience sort of a sense of the sort of things that are getting to be good practice. What’s the nub of those?
Daniel Summerfield: There are three or four key principles or proposals being put forward. One is a director’s database, which will allow the information that the Cayman Regulator collates on directors be made available. Now the actual details are still to be decided in terms of who’s going to have access to the information and indeed what information’s going to be provided. Currently CIMA are proposing that the funds information is provided on a fund by fund basis rather than actually being able to search on a director basis. So if you wanted to find out what positions a director holds that in current proposals would not be possible.
We’re thinking that that perhaps should go one step further, so one belt as a bona fide investor, one belt to understand what other commitments this individual has, and hopefully also be able to understand what commitments they held in the past. And this will first of all allow us as investors to undertake more effective due diligence of the director. We want people who’ve had real experience of hedge funds, who actually perhaps experience difficulties in the past as a director, but actually can enable us to understand what they did in those difficult situations to represent investors’ interests in an effective way. So we can actually use case studies when we’re doing our due diligence interviewing directors. That’s why we’re in favour of fully functional and fully search database.
The second proposal that’s being put forward is a more comprehensive statement of guidance, which we hope will act as a best practice guidelines and principles for directors, so they can understand what their duties, role and responsibilities are. As proposals stand at the moment we believe that they should go a bit further in actually drilling down to the specific responsibilities that a hedge fund director has. What’s been proposed at the moment is a generic set of responsibilities; we would like them to be more specific to a hedge fund context. We believe that there needs to be certain responsibilities which are articulated in that statement of guidance which will enable the directors to understand what cannot be delegated to the investment manager.
So first of all one example would be overseeing imposition of Gates for example, we believe that is a specific responsibility of a director which cannot be delegated to management. And if that was clearly spelt out in that statement of guidance I think it would level the playing field in terms of understanding of these responsibilities. We also believe that that statement of guidance should be put forward as a complier explain structure. Which works well for listed equities in the UK, we think it could work well for a hedge fund context as well.
So these aren’t going to be prescriptive measures, rather they’re going to be guidelines and principles. And if managers or the board of directors believe that that particular structure which is held out by the Regulator as best practice if that board of directors does not believe that those principles apply to their particular structure they can explain to investors why that’s not relevant, and then we as investors can make that informed judgement. So that’s a second proposal the statement of guidance.
The third principle is one which will require directors to be registered, and there are specific thresholds which are being put forward in terms of registration, so that there’ll be specific criteria for registration that’ll be required, and again whether that registration will lead to an oversight capacity, which the Regulator will have in determining whether or not these individuals are fit to stand as directors again being discussed. Our view is that the Regulator is not there to decide whether or not a person is appropriate director, that’s up to the investors to decide. We want that registration process to be undertaken so that information will be stored in a database and then we can make that effective and informed judgement.
Presenter: Thinking sort of a step backwards in some respects what are investors such as yourselves looking for in hedge fund governance and I think you’ve perhaps outlined some of this with regards to your concerns, but what are those sort of broad concerns?
Daniel Summerfield: We would like a board of directors composed of individuals who are largely and majority of whom are independent of the manager, who have got sufficiently broad depth of understanding of hedge funds, and also someone who has perhaps got experience of that strategy which the hedge fund is pursuing. That’s someone who obviously have investment management background. I think it’s also important to have someone who has an understanding of the Regulator, so perhaps a lawyer, and is also obviously someone there who needs to have financial understanding, perhaps that’s investment manager, perhaps that’s the persons come from the investment management background, but someone from the auditing profession may also be useful.
I think we’re looking for demonstration that that board is composed of the right individuals, that those individuals understand what their role and responsibilities are. They can give us an explanation or now due diligence calls. They can give us an indication of how they have represented investors’ interests in the past. These people are there as our first line of defence. It’s important we understand how the board operates, how it functions and what it believes its responsibilities are. I think we have in our mind what we believe the responsibilities of a director are, and I think it’s important that we ensure that that is communicated to the directors and the directors are able to explain to us how they can represent our interests on the board effectively.
Presenter: So good governance equals a strong board, maybe a strong board with teeth. Neil, do you sort of share that view of governance? Do you share Daniel’s view of governance? Is that what we’re looking for?
Neil Dolby: Yes, no, I definitely do. I guess we’ve been invested with hedge funds for a long long time now, so premarket crisis and post, so sort of we’ve seen the evolution of corporate governance over the years. One of the points I think I’d make is to say that we shouldn’t be wholly unfair on the industry from the point of view that there have been a number of players out there for a long long time who’ve actually had very effective corporate governance all the way through. So I don’t think we should describe this as a transformation or a change that’s happened sort of post-investment crisis; I think it’s been a steady evolution of a professionalisation over a long period of time.
From our perspective, I would certainly agree with Daniel that the invest pressure to actually achieve this is probably the most effective thing, because effectively you’re going to write out a ticket to actually invest in a fund and say sorry we’re not going to give you $50million until you sort out your governance, then almost certainly the governance will be improved. So I believe there’s a balance to be struck between the regulatory and standards and so forth, which are absolutely appropriate and so forth, and also investors working with managers to see the type of governance arrangements that we would like.
But I would say that there is a huge variation out there now. We’re happy to invest in a whole bunch of hedge funds right now. You have great governance who have independent chairmen, effective boards, quarterly board meetings with a sort of detailed agenda with all the service providers presenting. At the same time, you know, a couple of times this week across from my desk we’ve seen a couple of hedge funds, one a big US hedge fund that’s proposing to roll out a new fund. It’s got a couple of independents on there, but they have no intention of meeting as a board of directors at all, and all they’re going to do is sort of resolutions and me turn around and say that’s not acceptable.
So generally what we’re looking for is to ensure that of everything we invest in the standards are raised to a level which we think is acceptable looking at all the other controls and checks and balances which are there in there as well. I would like to say in ten years’ time we’ll have wonderful as Daniel’s saying like listed equities where we’ve got some real professionalism in the boards, but to start with we see that we have to raise the standards, invest in those which are a long way behind the curve.
Presenter: So to be clear for our audience that the standards of quality we’re expecting off our hedge fund boards and standards of governors are there for many hedge funds, but it’s about raising them all up to the same sort of standards and perhaps beyond also.
Neil Dolby: It is, this is a overgeneralization, but there tends to be a sort of geographic split. So in Europe, a Europe based manager will typically have pretty good governance, and Paul and I were talking about this earlier on, but it’s in part to do with availing the fund of the tax advantages in Cayman, so you’ve got to prove minor management being offshore, therefore you had to have a strong central management offshore. It’s in part to do with the UCITS guidelines that we’ve all come from and therefore there was this culture of effective governance.
In the US, given that most of the onshore structures are structured as limited partnership type structures, their concept of governance is more tricky in those situations, because you may have a GP which is itself a corporate and may have a corporate director on there. So with a US manager looking at both an onshore structure that has a large number of US investors and external investors through the offshore structures the concept of governance sometimes isn’t there. And it’s a question of sort of raising it to that standard. But again I would say that we’ve been invested with a number of US hedge funds for a long time that do have quarterly board meetings, totally understand the role of non-execs in the process as well.
Presenter: Paul, you’re nodding, do you have…?
Paul Govier: I completely agree with that. I think there is a huge cultural component. I think it does go back to sort of history repeating itself, my comments about it sort of being a cottage industry run by a manager in the US, again terrible generalisation, but a large number of US managers it’s the manager’s fund. He very much feels it’s his fund and they understand governance, but they think of themselves as governing it and not the independent board. And that’s a transition that I think the US is perhaps behind the curve on in Europe. Not to say the funds perform any worse necessarily, but they don’t have that same concept of the need for independence. And again I think it does also derive from the tax analysis as well, but we are seeing with our US client base a large shift in that regard.
When we’re talking about the sort of differential standards across managers I think in Europe it is quite, principally where my client base comes, it is quite advanced. I mean I think it’s a high standard of governance. The US I think it is more variable. But I think that derives more from the origins, if you like, the genesis of where the US hedge fund has come from, and its structure as well with the LPGB structure is slightly more complicated.
Presenter: Neil, to sort of sum up, I mean where are we now do you think sort of with regards the sort of utopia of sort of best practice, good governance? I mean where’s the industry placed?
Neil Dolby: Well I mean I think there has been great progress in the industries. So as I say from the start there’s always been good players, the market crisis really acted as a catalyst for a number of investors to get slightly more aggressive on the issue and actually promote best practice together with the regulatory regime, a best practice regime that’s been rolled out by the Hedge Fund Standards Boards and AMA, etc, so there’s been gradual progress. Where we are now well the answer is we’re not fully there.
So I mean as I say looking at some investments that we’ve made over the past or are seeking to make over the past couple of weeks I would say it’s about 50/50 with 50% of those being in great shape and the governance is ticking a box and 50% where, you know, if we’re to invest, then some improvements need to be made in the governance arrangements, which we would actively encourage.
So I would say that great progress has been made from a number of willing managers as well. So it’s sort of people generally understand why it’s got to happen, may not want to do it, but generally understand why, but I think we’re a number of years off that utopia where we can tick the governance box and worry about something else.
Presenter: Daniel, from an investor’s point of view would you agree with that? Are we at the sort of level you as a scheme would expect to see?
Daniel Summerfield: Yes. I think if you asked me that question last year I would have said glass half empty, this year I’m definitely glass half full. I think the regulators in Cayman obviously where most hedge funds are domiciled is moving in the right direction. They’ve recognised the fact they need to act. They recognise the fact that investors are becoming much more discerning. The reputation of Cayman as a regime, they want to protect and ensure that its reputation is maintained. There’s a lot of Cayman bashing going on out there in the media; these jumbo directorships which are being criticised as a model. They actually make up a minority of the business models of these direct organisations within Cayman, but it does give Cayman a very bad name. That’s not good for the Regulator, that’s not good for the manager and that’s certainly not good for the investor.
So I believe the Regulator recognises it needs to act. Investors also recognise they need to up their game in terms of incorporating these aspects into their due diligence process. They need to demonstrate to their clients, to their trustees if you’re a pension fund that this is a relatively safe asset class strategy that’s worth pursuing and there’s sufficient safeguards in place to protect our interests. Just one further point I agree with both Neil and Paul on all the areas we’ve discussed, the challenge if you like is to get the investment manager to recognise that they need to ensure there’s good governance in place in the fund from inception if they’re going to attract institutional money. And the irony is that when a hedge fund actually is set up the managers themselves would look for the directors to oversee the fund which they manage. And there’s no way round that, other than the advisers to the managers to ensure that they understand that if they’re going to attract this institutional grade money and the big tickets they have to get those directors who institutional investors are going to feel comfortable with. So it’s getting it right at inception rather than the managers and the directors and the fund board having to change once they’re going through the fundraising activity.
Presenter: And we’re on the right track now, but still some way to go?
Daniel Summerfield: There’s a significant way to go, but I think that we’re making good progress in the industry.
Presenter: I’m afraid we’re coming to the end of our debate, but in the context of the previous discussion what do you regard as the outlook for the coming twelve months?
Neil Dolby: Well Jonathan I’m optimistic, I mean we’ve seen massive progress in the industry over the past few years, and I see absolutely no reason why that won’t progress, so looking ahead to great governance across the board.
Presenter: Paul.
Paul Govier: We’re very encouraged that debates like this happening, that the performance of the hedge fund sector has been such that institutional investors continue to be attracted to it, that new hedge fund launches in Cayman are still very strong, that standards are lifting, the quality of service provider is high and that institutions like Aberdeen and USS are still committed to the sector and bringing with that all the qualities that an institutional investor brings. So again we’re very optimistic and thrilled to be part of that process.
Presenter: Thank you very much. Daniel.
Daniel Summerfield: I think we’ll end it on a realistic note, I think that we believe that there’s certainly significant progress made to date, the various constituents are coming together, they recognise the fact that a hedge fund as an industry needs to do something to attract inward investment, it needs to address investors’ concerns. I think we’re moving in the right direction, significant progress has been made. We recognise as an industry that the solution needs to come from within, we don’t want the regulators to regulate on our behalf, I think that there is no problem so bad that government intervention can’t make it worse as the saying goes and I think that there’s a recognition amongst industry players that we need to work together to ensure that positive outcome is achieved.
Presenter: Gentlemen, thank you. I’m afraid that’s all we have time for for this debate. All that remains for me to do is thank our panellists Neil, Paul and Daniel for their time and informative discussion, and to thank you our viewers for watching.
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