Progress report
An assessment of hedge fund YTD performance in the face of renewed fears for a potential eurozone crash Read More
22/06/2011
Comment: Vincent Vandenbroucke
With more institutions allocating capital to hedge funds, many leading industry players have taken significant steps to raise governance and operational standards. At Hermes BPK, we are playing a major role in driving this trend through our operational due diligence process, specifically through our active engagement programme.
Having re-calibrated the operational standards we regard as the minimum framework for doing business (clean background checks, identification of assets, proper segregation of duties, consistent and documented valuation policies, sufficient and scalable infrastructure and the necessary legal and compliance support), we believe we can go significantly further through engagement, by making best-practice recommendations to hedge funds that help them reach the highest level of institutional standards.
This engagement activity covers a wide range of topics but one of the critical issues we focus on is the requirement for all fund boards to have a majority of external directors, creating true independence to strengthen governance and oversight. We have been able to realise this goal across all our invested managers.
Another key issue we tackle head-on is the alignment of investment terms to the mandate of a portfolio, where often we find non-standard fee arrangements, redemption schedules, gates and performance fee calculation methodologies that we believe are either out of date or a legacy of the pre-financial crisis environment.
Our engagement activities also focus on a manager’s processes and resources for conducting the core functions. The relevant level of seniority and competence is sought to undertake legal, risk and compliance functions and Hermes BPK will make recommendations to management teams where we perceive gaps or deficiencies. On occasions, some hedge funds will have contracted with service providers or counterparties which are not meeting their specific needs. By working with multiple hedge fund investments, we are often in a much better position to recommend a provider that better fits a hedge fund’s strategy.
Another major engagement focus is on transparency and at Hermes BPK, we have granted our head of risk management a risk veto if transparency is below the levels that we expect – this covers the depth of data, timeliness of supply and access to risk personnel to query data. We do, however, actively work with managers to address transparency concerns and make them aware of our institutional expectations.
As businesses often have several fund structures, we will also engage to ensure managers have transparent and documented trade allocation policies to ensure all investors are treated fairly – where these are not in place, we will again seek alignment before investing.
While many of our engagement activities are purely recommendations, we find that our proposals are generally well received and typically implemented; in large part due to our ownership structure and the ultimate backing of the BT Pension Scheme. We are regarded as an institutional investor whose views are likely to be aligned to those of other prominent institutional investors.
Additionally, and most importantly, we have a philosophical aversion to special treatment through side letters and therefore expect any changes made by managers to be shared with all other investors based on a principle of fair and equitable treatment of investors. Our avoidance of bespoke agreements certainly resonates with managers, even if it results in the alteration of a process or an approach that has been taken as standard for many years.
Operational risk used to be defined as ‘risk without reward’ – we believe our engagement activity creates ‘operational alpha’ for Hermes BPK and all other investors, and provides a long-term benefit to hedge fund managers by making them a more robust investment proposition.
Vincent Vandenbroucke is the head of operational due diligence and partner at Hermes BPK Partners
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60 seconds with... Kenneth Turchin
CAN YOU DESCRIBE YOUR CURRENT ROLE?
I have worked in public accounting and hedge funds and in the past eight years have been selling middle- and back-office services to the alternate investment industry. My role is to build relationships with clients, teach them about SS&C’s products and services, and ensure seamless transactions every time the firm launches a new fund.
IF YOU WERE DOWN TO YOUR LAST £1,000, HOW WOULD YOU INVEST IT?
I would buy THREE shares in Apple and hope for a repeat 383% return in the next five years.
WHAT WOULD YOU DO IF YOU WERE IN PRESIDENT OBAMA’S SHOES?
That’s one pair of size 12 shoes I do not want to be in!
WHO WOULD PLAY YOU IF THEY MADE A MOVIE ABOUT YOUR FIRM?
Kevin Bacon. He is a versatile actor and the centre of the entertainment universe. I am in sales. Everyone in the industry would be linked to me in six steps or less. My client list would be ridiculous.
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