Hedge fund rules tightened
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Tony Featherstone is a Morningstar contributor and a former managing editor of BRW and Shares magazines.
Better labelling of hedge funds is good news for retail investors and for institutional investors that have lost share to rivals that use hedge fund tactics but are not marketed as such.
After two years of industry consultation, ASIC this week announced tougher rules on hedge fund disclosure. Australia is following a global push to strengthen hedge fund regulation through tighter disclosure and investment restrictions.
From June 2013, local hedge funds must provide more information to help investors understand key risks and compare funds and products. The corporate regulator also wants greater transparency that pushes hedge funds to adopt better governance practices and enables fraud to be discovered earlier.
The absence of a universal definition of a "hedge fund" has been a problem.
Such funds are distinguished from managed investment schemes through their use of leverage, derivatives or short-selling, or through the fund's goal to seek returns with low correlation to equity and bond markets.
Another characteristic that sometimes defines hedge funds in Australia is the use of performance fees (in contrast to fees based on funds under management).
Managed investment schemes are technically defined as hedge funds if they have two or more of the characteristics mentioned.
Some small-cap Australian equity funds, for example, have capacity to short-sell stocks and their manager receives performance fees, in addition to a fee based on funds under management.
Yet they are not labelled as hedge funds, and their managers might seek to avoid the label because of poor publicity about hedge funds after the large-scale collapse of Trio Capital and other funds, or because the fund does not want it widely known that it bets on falling share prices, which can alienate companies and restrict the fund manager's access to management.
Several of Australia's best-performing small-cap Australian equity funds in recent years, and even some better-performing funds that are managed by listed investment companies, arguably have hedge fund characteristics but are not promoted this way.
ASIC said: "Through our surveillance of the managed funds industry, we have noted many schemes that exhibit hedge funds characteristics, such as complex investment structures and the use of derivatives, leverage and short-selling, but are not marketed or promoted as hedge funds."
"Hedge funds come with risks greater than those associated with the majority of financial products offered to investors. We are concerned that a lack of adequate disclosure is resulting in investors being exposed to a heightened risk when investing in these kinds of products."
"Investors are unclear about the nature of the products and whether the products are appropriate to meet their own investment needs, objectives and risk profile."