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Hedge fund raters’ rating is only ‘fair’ – they could do better

Hedge fund rating is a noble goal but Moody’s and S&P’s approaches fail to fill the bill.

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”.

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