Guide to Institutional Investors’ Views and Preferences Regarding Hedge Fund Operational Infrastructures

Governance:

This is my 2^nd post in a series, abstracting the white paper issued by the Alternative investment management association “AIMA”.  This document reflects the views of investors and is written to educate the AIMA’s constituents (investors).  The section on governance is is authored by Luke Dixon of Universities Superannuation Scheme.

“Their is a growing importance of good fund governance and by association, high quality independent "directors".  Conflicts of interest frequently exist between the hedge fund’s board of directors (if they are any), investment managers and the fund’s advisors.” These conflicts can often lead to decisions being taken in the interests of the hedge fund’s investment manager rather than in the interests of the fund and its shareholders as a whole.  The threat is this governance is contrary to the fiduciary obligations of the fund’s directors. 

Investors recommend that governance structures and oversight responsibilities should be in place to protect them, and want all oversight responsibilities to be undertaken by responsible, knowledgeable and independent fiduciaries. Despite the private nature of hedge fund investments, the trajectory of their governance is towards the public market model of strong, independent boards and democratically empowered investors.

The section continues to outline what investors would consider an ideal governance platform. 

Investor shares should provide relevant voting rights.  As an example the voting rights might include

"the appointment and removal of the investment manager; the election of directors; approval of directors’ fees; In addition, these fund shareholders should be able to nominate directors; file a resolution at general meetings; convene an extraordinary general meeting; while the fund’s registrar should facilitate investor communications, solicitations and proxies, in this respect."

•   Service providers periodically report directly to the board. 

•   Information prepared by service providers should be delivered directly by them to the  board. This reporting distinction explicitly recognizes that the service providers are contracted by the fund rather than by the investment manager.

•   The” board” should have much more of a say in the valuation of securities. Security pricing should not be left to the discretion of the investment manager.

•  The board should be empowered to monitor and replace the fund’s service providers, including the investment manager. 

The hedge fund’s Offering Memorandum should be sufficiently precise when describing the fund’s investment strategy and appropriate investment restrictions, to serve as a guide for director and investor oversight.

Investors would also like to see that decisions to invoke fund gating mechanisms and side pockets, or to suspend fund redemptions and net asset value (“NAV” hereafter) calculations, to be also the responsibility of the board of directors


How much of this idealistic view of what investors want will become reality is yet to be seen. However, it is very clear that hedge funds are moving from a private organization structure to a more transparent model.