[Congressional Record (Bound Edition), Volume 151 (2005), Part 14]
[Extensions of Remarks]
[Pages 19376-19377]
[From the U.S. Government Publishing Office, www.gpo.gov]




               BEST PRACTICES IN THE HEDGE FUND INDUSTRY

                                 ______
                                 

                         HON. CHRISTOPHER SHAYS

                             of connecticut

                    in the house of representatives

                        Thursday, July 28, 2005

  Mr. SHAYS. Mr. Speaker, the hedge fund industry plays a critical and 
special role in our capital markets and is enormously important to 
helping institutional investors diversify their investment portfolios 
and meet their future funding needs.
  While the numbers fluctuate some, there are believed to be close to 
8,000 hedge funds that manage approximately $1 trillion in assets. 
Connecticut's Fourth Congressional District, which I'm very proud to 
represent, is the home to several hundred of the most successful hedge 
funds.
  Over the past few years, the industry has received increasing 
attention from the media, Congress and the Securities and Exchange 
Commission (SEC). I happen to believe that strong oversight of our 
financial markets is critical to our nation's economic well-being, but 
recognize that with sophisticated and knowledgeable investors, hedge 
funds do not require the same level of scrutiny as is paid to the 
mutual fund industry. Nevertheless, it seems to me that more 
transparency and better government and regulator understanding of the 
industry will ultimately benefit investors and managers alike.
  The Greenwich Roundtable is a not-for-profit organization, based in 
Greenwich, Connecticut with a mission to promote education in 
alternative investments. This thoroughly professional and thoughtful 
institution has produced a report entitled, ``Best Practices in Hedge 
Fund Investing: Due Diligence for Equity Strategies,'' that I hope will 
serve as an important reference for this body, for investors and for 
others interested in our capital markets. The goal of the publication 
is to ``help demystify a topic that has been shrouded in myth and, by 
doing so, help improve the level of education among those who wish to 
better understand the community of active hedge fund investors.'' It 
seems to me this is a very important document and would recommend it to 
any of my colleagues with an interest or concern about the industry to 
review it.
  An abstract of this report is below, and I again would like to 
express my appreciation to the Greenwich Roundtable for this important 
and timely publication.

          Best Practice in Hedge Fund Investing: Due Diligence

       This publication is the first collaboration of its kind, 
     between investors and managers. The goal of this publication 
     is to help demystify a topic that has been shrouded in myth 
     and, by doing so, help improve the level of education among 
     those who wish to better understand the community of active 
     hedge fund investors, This is the first issue of the planned 
     series of Best Practices in Hedge Fund Investing.

[[Page 19377]]

       Inside this first issue, you will be treated to an informed 
     examination into the art of due diligence. The scope will be 
     confined to examining equity-oriented strategies. The 
     universe of hedge fund strategies is enormously broad and 
     diverse. Any single method of inquiry applied to all due 
     diligence would become generic. Future issues will cover 
     strategies in other areas such as managed fixtures, fixed 
     income and asset-backed markets.
       The investors who created this publication are members of 
     our Education Committee. Their backgrounds are broad and 
     diverse. They hail from the family office, bank proprietary 
     capital, or fund of funds communities. They are all seasoned 
     investors in a broad range of strategies. For two years, our 
     purpose has been to uncover ``soft'' aspects of performing 
     hedge fund due diligence. Our emphasis is on developing an 
     interpretative discussion whenever a flag is raised. There 
     have been many generic investor questionnaires circulated. 
     Most were focused on collecting quantitative data. 
     Quantitative analysis is backward looking. Qualitative 
     analysis is more useful as a forward looking tool.


                           Selected Excerpts

       Strategy, Investment Process, and Market Opportunity--A 
     critical first step in any evaluation of a hedge fund 
     investment is the establishment of a proper context for the 
     evaluation. Once the context for the evaluation is properly 
     understood, it is possible to proceed with a more nuanced 
     investigation of the investment strategy, the portfolio 
     manager's edge, and other relevant fund particulars.
       Team and Organization--The quality of a firm's human 
     capital will contain, perhaps the strongest clues about its 
     prospects for sustainable success. Moreover, the success of 
     the organization requires both investment and business 
     management acumen, skills that rarely reside in equal 
     proportion in any single investment professional.
       Fee Structure and Terms--The evaluation of a fund's fee 
     structure and terms is essentially an exercise in 
     understanding the value proposition of a particular hedge 
     fund investment. Much of this will depend on the 
     circumstances and environment in which the investment 
     opportunity is presented. In the end, an investor must 
     ultimately determine whether the terms and conditions for 
     this investment are reasonable and fair.
       Management Company, Fund Structure and Asset Base--An 
     evaluation of the hedge fund's management company should be 
     focused on the question of what kind of business it is. In 
     the final analysis, an investor needs to understand if there 
     is a true alignment of incentives between the prospective 
     investor and the portfolio manager in regards to their 
     investment objective.
       Quantitative Review--Many experienced hedge fund investors 
     appear to view quantitative analysis as a valuable 
     complement, rather than a substitute, for more qualitatively 
     drawn judgments. Deployed intelligently, certain quantitative 
     disciplines can help confirm the wisdom of more qualitatively 
     drawn judgments and assist in highlighting aspects of the 
     investment strategy that warrant further investigation.
       Operations and Transparency--There is a big difference 
     between portfolio transparency and translucency. Transparency 
     implies a more substantially active role on the part of the 
     manager in identifying and clarifying key risks for 
     investors. Translucency implies a simple commitment to 
     provide a clear view of the portfolio holdings and may not be 
     very helpful in informing the investor.
       Third Parties--Evaluating the quality of the third-party 
     vendors, as well as understanding the intersection of in-
     house and third-party business management, is critical to 
     understanding how disciplined the hedge fund business and 
     investment processes truly are.
       Intuition, Judgment, and Experience--No amount of due 
     diligence can completely replace the importance of experience 
     and intuition when investing with a hedge fund manager. 
     Finally and most importantly, would you invest your own money 
     or your family's money with this manager?

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