EUROPE - Transparency is usually considered to be an unalloyed positive when it comes to hedge fund investing and reporting. But a new empirical study, presented at the 4th Lyxor/NYSE Liffe Hedge Fund Research Conference in Paris, shows that greater regulatory transparency from individual hedge funds can lead to significant costs in terms of lower returns, higher fees and greater correlation with other funds.
Zhen Shi of Georgia State University, in ‘The impact of portfolio disclosure on hedge fund performance, fees and flows’, examined the characteristics of a sub-group of funds before they began filing 13-F portfolio disclosure to the US regulator, the SEC, and after, for the period 1994-2010.
The sub-group were funds with assets under management at or around $100m (€76m) because this is the threshold over which funds must begin filing the disclosures with the SEC. Shi noted that this was to control for the effects of size on performance.
The research found that the returns to the funds fell by 4% annually on average after they began reporting - and recovered for the test group of funds that went the other way, from reporting to not reporting.
Shi did not present any conclusions as to why this effect was evident, but discussed the possibility that funds that were content to take more risk when they were not reporting became more conservative once they began - the study did not examine the effect on risk-adjusted return.
Further, while Shi said it was impossible to be sure that other funds were “free-riding” on revealed positions of reporting funds without transparency into the portfolio positions being reported to the SEC, regressions revealed a significant rise in the r-squared coefficient of determination between a fund’s returns and broader hedge fund returns once it began reporting.
Hedge funds appear to become more like one another when they begin reporting portfolio positions to the SEC.
Finally, the study found that investors’ fees were on average 1% higher for the same fund after it began reporting to the SEC, compared with before.
Again, reasons were not offered, but discussion threw up suggestions ranging from the need to compensate for falling returns, to a simple reflection of the administrative costs of reporting to the regulator, to a life-cycle effect (smaller, younger funds tend to charge lower fees to attract their first investors, and passing the $100m threshold could be the trigger to move towards the industry average).
“The cost of portfolio disclosure is economically large,” Shi concluded. “So how do investors value disclosure? They may like the transparency, but they may also be concerned about the impact it has on the performance of their investment.”
Shi answered that question by considering the change in fund flows, controlled for performance, that occurs once a fund begins reporting to the SEC.
Perhaps surprisingly, the data indicates that fund flows do not change at all. Apparently, investors value the extra regulatory transparency neither negatively or positively.
The discussant for the paper, Istvan Nagy of the University of Neuchatel, noted its importance in the discussion around regulatory disclosure.
“You can request confidentiality treatments from the SEC - but they are generally refused,” he said.
“This paper may give hedge fund managers empirical evidence to support their requests in future.”