Private banks are letting down their clients by offering hedge funds without providing unbiased information about the product, according to ...

Private banks are letting down their clients by offering hedge funds without providing unbiased information about the product, according to the director of Europe's first Centre for Hedge Fund Research and Education. The centre, opened in London last week, is expected to become a leading academic authority and focal point for new ideas on hedge funds amid rapid growth in the alternative investment product. Dr Narayan Naik, the centre's director, said there was a need for unbiased education in the industry. "You have these high net worth individuals but they are being educated about hedge funds by hedge fund managers and that is not an ideal way of getting education because it is not an unbiased opinion," Naik told Private Client Management. "It doesn't give the whole picture no matter how many managers they speak with, because managers are secretive about their trading strategy."

Hedge funds have emerged as a major investment option in the private banking industry in response to equity market volatility and the accompanying pressure from investors to hedge their portfolios against a downturn. Naik, however, said that investors were being duped into believing some hedge funds were risk-free when they were in fact not. "Some of our work shows that the so-called market neutral and non-directional funds contain a lot of risks. They often have systematic risks in the same way traditional mutual funds have. If that is the case, then the risk-free rate of interest they use as a benchmark to claim their incentive fee is not the correct benchmark so they may be getting overcompensated. If the investor doesn't know, he may end up paying too much," he said.

A number of private banks are increasingly promoting alternative investments amongst their clients and investment managers, although the bigger organisations are more wary of including them within model portfolios. UBS clients typically invest around 15 per cent of their assets in alternatives which includes real estate allocation, according to Michael Strobaek, deputy chief investment officer of UBS Asset Management. Adrian Fairbourne, vice president and head of investments for Europe at Bank of Bermuda, revealed that around 10 per cent of every client’s investment model is allocated to alternatives, while some invest a proportion as high as 30 or 40 per cent. Coutts has said since launching Orbita, its fund of fund alternative investment service in 1998, the bank now invests more than ten per cent of its private client assets in hedge funds.

One of the biggest challenges for the industry would be gaining respectability, Naik said. Research by the centre has found that half the funds on the market have a shelf life of two years. "That means in two years, half the funds which have started will no longer be in business. It is partly an indication of some young guys who may be working in some brokerage firm thinking they can run long short portfolios. They are indeed many opportunistic managers like that and there are limited controls on hedge funds so they are able to do that," said Naik. Creating a better reputation would require co-operation between hedge fund managers, he said. "To create this reputation, everybody has to come together and people should not be opportunistically defrauding. That is very difficult to achieve because you need coordinating, collusion, or some understanding among hedge fund managers and there is no such body that will do that. Even if there is a body, it is unenforceable."

That sense of creating a central information point is where the centre comes in. It was established as the result of an initiative taken by Fauchier Partners, a London-based specialist in the construction and management of customised portfolios of hedge funds. Based at the London Business School, it is backed by a number of firms involved in the hedge fund industry, including Bank of Bermuda, BNP Paribas, Deutsche Bank, Merrill Lynch Investment Managers and The Prudential Insurance Co of America. Professor Richard Brealey, formerly adviser to the Governor of the Bank of England on financial stability, is chairman.

Naik said the centre would also probably debunk some myths about the risks of hedge funds, as well as pointing out any faults. "Out of 4,000 or so hedge funds, the problem cases are maybe 10 or 15 and that is less than one per cent. You'll always find cases where things have not been done correctly, but that is not specific to hedge funds. If you don't know what the manager is doing, you don't have to invest. This is consenting adults."

The centre will also provide education at a more practical level by working on a wide variety of initiatives from the introduction of new electives on the School's MBA and Masters in Finance programmes to the development of the Investment Management Evening Programme and specific executive education short courses. Two-day seminars for fund trustees or private bankers will begin in Spring 2002.