It is therefore intriguing, but unsurprising, that the parallel management of traditional long only products and hedge funds by the same organization has come under increased scrutiny. To quote a 2003 Staff Report to the SEC: "unique facts, however, including the nature of fees paid, the interests of their adviser and the nature of the hedge fund investment strategies themselves, distinguish hedge funds from other pooled investment vehicles…(sic) … and bring these conflicts into even sharper focus."
Martin Currie launched its first equity long/short fund in June 2000. A further six absolute return funds have subsequently been launched. By December 2004 hedge fund assets totalled $1bn out of a total firm-wide funds under management of $15bn. Crucially the hedge funds are not a separate, stand-alone business. Fund managers run both hedge funds and longonly strategies. They enjoy the same research resource, operational support and systems infrastructure provided to the long-only funds.
Clients and consultants are naturally interested in our business model. As part of their due diligence process, they ask: how can we manage effectively the two businesses in parallel? Are managers incentivised to manage all funds equitably with the same level of professionalism, integrity and expertise? Are our best investment ideas made available to all client funds? Does our corporate planning process inherently favour one part of our business to the detriment of others? And so with regulators taking a growing interest in hedge funds, we decided in early 2004 to take the initiative and formalise our policy and procedures with respect to managing potential conflicts of interest.
'Potential' is a keyword. We believe that an organization with a robust code of ethics and strong compliance management can effectively mitigate the risk of conflict. But it is important that policies are continually reviewed in light of industry sentiment and business evolution.
A team made up of the heads of legal & compliance, dealing and risk management led the project. The objective was to scrutinise all aspects of our business to identify practices that could cause conflicts of interest across all client funds. Existing policies were to be tested for effectiveness, and enhanced where necessary. New policies and adherence procedures were to be introduced where required.
But the first step was to appreciate how our peers were responding to this issue. We asked independent management consultants to prepare a 'gap analysis', looking at UK and US-based organisations managing both longonly accounts and hedge funds. We were surprised by their swift response. Very few, if any, had formalised their conflict management philosophy and policies. It appeared we were breaking new ground. This was both pleasing and disappointing. Pleasing because taking the lead can offer a competitive edge; but disappointing because the apparent inertia has the potential to hinder the recognition of hedge funds as a mainstream asset class.
We then embarked on an extensive consultation exercise with colleagues drawn from all parts of the business. Clients' opinions were also canvassed.
Thirteen distinct activities were identified as practices that could give rise to conflicts of interest. These include:
* Contradictory positions. Should fund managers have full discretion over their security selection and thematic biases? Or are tight risk controls required to ensure consistency of approach?
* Communication of investment ideas. How can we ensure viewpoints and ideas are freely disseminated across the investment floor?
* IPO application and allocations. There should be no systematic discrimination against any client or fund type
* Broker relationships. Brokers should be encouraged to target their services at regional product teams rather than managers of specific clients/funds
* Product capacity management. How do we protect the interests of existing clients as funds under management increase?
* Reward and remuneration. The structure must incentivise all staff to achieve excellence in all aspects of their work
Fleshing out the policy details is a lengthy process. Delivery of a principled framework that satisfies the interests of all stakeholders – the managers, clients and regulators – is challenging enough on its own – but can then be fraught with implementation difficulties.
One facet of a contradictory positions policy is the ability, or otherwise, to short a stock that is held as an overweight position (relative to benchmark index) in a long-only account. Proponents argue that prohibition is unfair to one group of clients, denying them the opportunity to exploit the full universe of investment opportunities.