Hedge fund investors want some comfort that they will not be entrusting their money to shady characters and, given that the regulatory environment does not offer any such assurance, a rating system for hedge funds is without doubt a decent idea.
In an ideal world, this oversight would be provided by funds of hedge funds or by the banks that evaluate hedge fund managers for credit. Sadly, though, a few funds of hedge funds are beginning to tarnish the credibility of the investment vehicle as a provider of high-quality due diligence. And, understandably, banks do not wish to deal with the conflicts of interest that might arise were they to undertake manager rating. So we are left with third parties. And who better to do it than the ratings agencies? It is, after all, their job.
But looking at the propositions for hedge fund rating recently put forward by the agencies, there is a feeling that their ideas are as ill-thought-through as the SEC’s now abandoned attempts to regulate hedge funds.
Take Moody’s approach. The agency has opted for a bizarre ratings spectrum of OQ1 to OQ5, with the former being “excellent” and the latter “poor”. Notice there is no “fail” – the obvious reason being that managers would be unwilling to pay to have a “fail” rating made public. But then, what manager would pay to have a “fair” rating published? Already one manager that has paid to be rated by Moody’s has declined to have that rating published, for unknown reasons. The second manager to be rated by Moody’s received an “excellent” rating. A cynical observer might find that a little too convenient.
Standard & Poor’s approach (perhaps benefiting from being put together after Moody’s) is somewhat better, and sticks to its AAA to C rating system; it also at least attempts to address elements of analysis of investment. More convincingly, S&P has rated two funds from the highly regarded and institutional-like Citadel at BBB. According to S&P, this is a good rating for a hedge fund and to be expected. It’s hard to see, however, that, if faced with a choice, a pension fund would opt for a BBB manager over one that scored “excellent”.
One can’t help but wish that the agencies had put their heads together and come up with a serious and at least complementary proposition for rating the hedge fund industry that would truly benefit investors and encourage managers to sign up to be assessed.
