Hedge Fund Governance

In the wake of the financial crisis and the Bernard Madoff scandal, hedge fund governance has become more important than ever.   In the following video, I cover some useful hedge fund governance best practices and practical strategies.

Video Transcript/SummaryThe strategies and tips provided within this video module include:

  1. Governance best practice is related to becoming the more institutional quality firm and is now a common topic because institutional investors typically only invest in people that meet a certain checklist box mentality.
  2. Having leading proactive governance practices can be a competitive advantage in the hedge fund industry, where skepticism is often prevalent and where everyone is interested in transparency.
  3. Separation of duties, such as those of the risk management and portfolio management teams, is important, as is the need to have best practice financial controls in place. There are many consultants who can help with getting these financial controls set up.
  4. Biggest takeaway from our interviews is how important and beneficial it is to to form an independent governance board that essentially takes the side of the investor and represents their best interests.
  5. Independent governance boards can oversee and ensure best practice in relation to hurdle rates, performance reporting and costs, with regards to service providers and the business as a whole. 
  6. Despite the clear benefits, many small-medium sized funds are not implementing these best practices.
  7. In summary, governance best practice is extremely important for hedge funds, who should consider separating duties within their business and put in place an independent board of directors to facilitate transparency and representation of clients best interests.

Transcript for Hedge Fund Governance

Hello, this is Richard Wilson and today we’re going to talk about the importance of governance best practices for hedge funds. You know I read some book, we have a whole chapter on governance best practices because I think it’s such an important topic, it is related to becoming the more institutional quality firm which everybody talks about because everybody knows that the institutional investors typically only invest in people that made the certain checkbox mentality and having a leading proactive governance can be a competitive advantage in the hedge fund industry where everybody is interested in transparency, everybody at some level kind of distrust other parties in the industry until they’ve done their due diligence. So having this type of governance is really going to ensure investors that you have their best interest in mind.

One of the most important things about having good governance procedures in place is to have separations of certain duties, like having the operational or like the risk manager is separated from the portfolio manager. It’s also about having just general best practice financial controls in place. There’s many consultants out there that work in a hedge fund industry and other industries. They can help you put in place basic financial controls so that you’ll at least have some level of checks and balances and how things are approved such as payments to service providers, wire transfers, redemptions. There should be some thorough checks in that area and documented so that investors can see that there’s proper governance in place.

And I think that the biggest takeaway from interviewing people in the area of governance and consulting a risk management, the most important thing that I found hedge funds can do is to form an independent board, a governance board which takes the side of an investor. These are non-executive board members that take the perspective and the side of the investor and protect the investor’s interest within the hedge fund. So the board might meet on a monthly basis and they’d meet for a longer period maybe in-person on a quarterly basis, and they can help by looking at when gaining clause are enacted and helping control that and look at hurdle rates making sure those aren’t adjusted at strategic times, looking at performance reporting, whose chosen the service providers, why certain cost are taking, what the expense ratio is within the fund.

They can look at many different things with the more critical eye and vote on improving or not improving certain actions in ways that I think investors really appreciate and lots of hedge funds are not doing this right now, lots of large ones are, lots of small, medium-sized ones are not and this is one thing that can really help your hedge fund stand out is being proactively well-governed. So that pretty much covers what I wanted to talk about today. The main takeaways are that governance is very important. It should be something that your team is studying and improving whether you go look to work in a hedge fund or you already run a hedge fund.

Look at strong financial controls in place, think separation of duty and checks and balances and then third, probably the most important, look at possibly creating at least at some point a board that is looking at things, an independent board, non-executives and look at things from the investor’s perspective and make sure that the investor’s best interest are always at least taken into consideration while decisions are being made inside the hedge fund.

So thank you for your time today and we’ll see you again soon.

While the scandals that have erupted over the last few years like the Bernie Madoff fraud have certainly damaged investor confidence and the reputation of some funds, it has also presented an opportunity for funds that have a strong focus on governance to attract investors this quality.

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About Richard Wilson