The 7 Habits of Highly Suspicious Hedge Funds

In a post-Madoff world this blog post from Rick Bookstabber titled "The 7 Habits of Highly Suspicious Hedge Funds" makes good reading.

It confirms my thinking that hedge funds will fall into two broad groups going forward. First, those that operate under a veil of secrecy and use leverage and sometimes unlisted securities. And then there are those that rely on an open and transparent process with listed securities and no leverage.

The key safety factor for investors is the separation of custody and administration from investment management. Not just Chinese wall separation, but real separation. In Australia, the role of independent Responsible Entity provides that separation for retail investors and other investors participating in an ASIC registered Product Disclosure Statement. For institutional investors using managed accounts, the role of custody and investment management is clearly separated.

For investment managers that are also Responsible Entity and perform custody and administration functions, the burden of ensuring separation of roles is necessarily greater.

Funds that have open and transparent processes, that don't require leverage to produce returns and are prepared to publish holdings (even with a lag) will be more likely to gain the confidence of investors.