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Investor protection: Why bother rating hedge funds?

Benefit of hedge fund ratings to investors is questionable.

In theory, it sounds like a good idea – publicly rating hedge funds according to their level of operational risk. But whom exactly is it helping? In July this year, Moody’s Investors Service announced its criteria for rating hedge funds; in September, Standard and Poor’s followed suit.

Funds of hedge funds, which can perhaps be seen as having the most to lose from a rating system, have been quick to highlight the ratings’ failings. Investors tend to buy into funds of hedge funds on the basis that these funds have due-diligence expertise. If investors can receive this information for free from ratings agencies, will they stop using funds of hedge funds? Francois Barthelemy, partner of fund of hedge funds business F&C Partners, says it would be dangerous for investors to rely on ratings as their primary method of due diligence. “There is not the level of information that you need from these operational risk ratings,” he says. “They do not tell you about the investment process or how the manager perceives the opportunity set. Investors shouldn’t fool themselves, they should do their own homework.” S&P’s ratings criteria appear to take into account some aspects of investment and performance, whereas Moody’s made a conscious decision to focus on operational risk only.

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