The current document starts out as its last predecessor did, horribly. Recommendation 1.1 is “A Hedge Fund Manager should establish management policies and practices appropriate for its size, nature and complexity and for its trading activities for each Hedge Fund it manages.”
There are three things wrong with this recommendation. First, it is not a call to action. Among the hundreds of hedge fund managers I know, including a number who are criminally incompetent, I can’t think of one who wouldn’t claim that he is already following this recommendation.
Second, this recommendation places the emphasis on the hedge fund manager and his business, not on the protection of the investor’s money, which is where the emphasis belongs. This recommendation should read: “The Hedge Fund manager will establish management policies sufficient to manage his fund professionally and prudently. The Hedge Fund manager will use the industry’s best practices—unless he has strong evidence that his own practices are superior.”
Third, this recommendation suggests that the manager do the least he can get away with. In my review of the previous version I added, “…which is what a good lawyer should suggest, I suppose. The MFA never suggests doing the most we can do for our investors.” But then, after a discussion of information technology, the document takes a remarkable, delightful and unexpected turn; the document has a large section on the Hedge Fund manager’s responsibility to his investors. I can’t overstate how important this innovation is. These days, few hedge fund managers are as bad as the management of Lloyd Carr and Company were. Lloyd Carr’s management used to refer to their customers as “mooches” and tell their salespeople, “The mooch has your money! You got to get your money from them!” On the other hand, few hedge fund managers treat their customers with the respect they deserve. A hedge fund manager who treated his investors with respect would not, for example, ask himself, “what does the law demand I put in my disclosure document?” but “what do I need to tell my investors so that they can make wise decisions about my investment products?” The evidence I have seen tells me that any hedge fund manager who ran his business that way would build customer loyalty and cut his legal bills; he would exceed the demands of the law. The MFA does not go as far as I would here. But they go far compared with where the industry is right now, almost certainly further than most of their members want to go, and for that, honor is due.
The MFA’s attitude here carries over to many other sections of this document. For example, bizarrely, this attitude also colors their discussion of risk management. I say bizarrely because this section starts, hideously, with “A Hedge Fund Manager should have a risk measurement process appropriate to its size, complexity and portfolio structure.” This implies that the proper risk measurement and management is a function of what the hedge fund manager can afford. This is like saying that a surgeon shouldn’t have to worry about amputating the wrong leg if he works in a very small hospital. Then the MFA’s writers redeem themselves writing sensibly about risk management topics that are important but seldom discussed. Their discussion of cash and credit lines, for example, is quite good. The section on asset valuation is also quite good. If it doesn’t come to industry best practices, well, it comes close.
The fact that this document doesn’t come up to our industry’s best practices is a serious criticism of the document. There is little point in saying less than your predecessors. The name of this document “Sound Practices” rather than “best practices” suggests that this failure is not a mistake, not an error of knowledge. The authors argue that this is because no one solution fits all hedge fund managers. This is a fair point. But it is also true that not all ideas are of equal value and sometimes we really do know what we are talking about. In my opinion, the MFA’s position here is either a failure of nerve or an attempt to say something useful without threatening the reader. Given the gigantic size of many hedge fund managers’ egos, I suspect the latter.
Much of the rest of the document is a long discussion of regulatory issues, which are important but annoying. For example, the document has a long section on anti-money laundering practices. As a patriot, I support such things, but I don’t support them with any enthusiasm. I know from personal experience how arbitrary such rules are. I lived in Abu Dhabi for seven years and they do things differently there. I bought my Volvo for cash; the car dealership didn’t accept checks.
No one from the MFA called to thank me for my last review, the D. I get that a lot. I would give the current version a B-; the MFA has a long way to go, but the MFA is clearly going in the right direction. The industry is growing up.
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