Institutional Investor's Alpha Magazine - December 2008 / January 2009 - (Page 42)

Grading Hedge Funds of research and new product development. From the investors’ side of the equation, then, ratings are perhaps as much in demand as ever. The other, smaller end of the market, in which hedge funds themselves arrange for ratings to conﬁrm the quality of their debt, has faded with this year’s collapse of equities and freezing up of credit markets. This part of the ratings game — controlled largely by New York–based ﬁrms Fitch Ratings, Moody’s and Standard & Poor’s — has faltered along with the economy. “It’s fairly dead, and it will be a long time before hedge funds come back for ratings again,” concedes Eileen Fahey, a managing director of Fitch’s ﬁnancial institutions group. “The environment is very tough right now,” agrees John Hagarty, chief operating ofﬁcer of FrontPoint Partners, a Greenwich, Connecticut–based hedge fund ﬁrm. “While I wouldn’t say we are uninterested in ratings, it is deﬁnitely not in our top priorities at this time.” Part of the push early this decade for ratings came from hedge funds seeking third-party afﬁrmation for their operations in order to attract investors and underwriters. Skeptics questioned how plausible it was for Moody’s, S&P and Fitch to issue informed opinions on hedge funds, which are typically much less transparent than the corporate and public debt and structured-ﬁnance deals the ﬁrms are better known for rating. “It’s not clear how successful they are at evaluating the kind of complex and heterogeneous risks that hedge funds contain,” says Andrew Lo, the well-known MIT about hedge funds, Friedman asks, “why in the world would they be working for a rating agency?” In an effort to assess the hedge-fund-fueled end of the markets, Fitch in March gave BBB+ ratings to Citadel Kensington Global Strategies and Citadel Wellington, the two biggest funds run by Chicago-based Citadel Investment Group. (In October, Fitch lowered the rating to BBB and the outlook from “stable” to “negative.”) In cooperating on ratings, Citadel — which is very much the exception among hedge fund ﬁrms in this regard but is suffering as much, or more than, many in 2008, down by 47 percent through November — hoped to lessen its dependence on prime brokers by attracting a separate stream of ﬁnancing. A respectable rating shows that a fund has the wherewithal to repay debt and is free of the need for prime brokers’ capital, making it especially attractive these days, as brokerages themselves grow increasingly shaky. Jacqueline Meziani, director of S&P’s ﬁnancial institutions ratings, argues that although ratings are helpful to investors, they can also be valuable to hedge funds. “It’s worth the scrutiny to discover even negative credit factors because it can be illuminating,” she says. “It provides feedback from an objective third party.” S&P, which rates 16 alternative-investment funds, has a small ratings team with standard credit-analysis experience augmented by people who have worked for hedge funds, Meziani notes. “The analysis is intense,” she says. Though well-known, industry-comprehensive and widely accepted ratings will probably remain elusive until hedge funds become less opaque, there remains a well-funded third-party demand for such knowledge, argues Joseph Omansky, founder of Sky Fund. His small Princeton, New Jersey–based company’s SkyRank System tracks 4,310 hedge funds and 3,648 funds of funds and issues ratings on about 85 percent of them. The system is entirely quantitative, Omansky says, taking into account cash under management, leverage, volatility and historical returns, among other things. SkyRank’s ratings range from A+, the top end of the spectrum, to E at the bottom. Worth noting is that as of the end of October, SkyRank gave 37 percent of the hedge funds it rates an E, up from 6 percent a year earlier. That is “due to the credit crisis, deleveraging and forced liquidation,” he reports. The value of a system like SkyRank, Omansky asserts, is in what he says is its unique level of purity. “Getting paid by companies to rate their ﬁrms, whether in bond, stock or hedge fund ratings, is not a viable model, as it represents a deep conﬂict of interest,” he argues, noting that SkyRank is subscriber-based. Still, the hurdles that confront sound ratings persist. Hedge fund managers, administrators and investors point to the variety, complexity and secrecy of hedge funds, observing that strategies employed in one fund’s environment may not work in another’s. “They are difﬁcult to encapsulate with a single analytical data point,” notes Kenneth Heinz, president of Chicago’s Hedge Fund Re- “There are so many nuances, so much distinctiveness — it’s the idiosyncrasies that make each fund what it is.” — RACHEL MINARD, PRESIDENT, COGO WOLF ASSET MANAGEMENT Sloan School of Management–based scholar and hedge fund manager. Lo says that although it makes sense intuitively for there to be a hedge fund rating system and that such a system could be tremendously useful (especially to institutional investors, which have ﬁduciary obligations to invest prudently), rating ﬁrms still lack the deep analytical tools to pull it off. “It will be some time before they gain the kind of acceptance that debt ratings have achieved,” he notes. Other skeptics, such as Greg Friedman, chief investment ofﬁcer of Pittsburgh-based investment consulting ﬁrm Greycourt & Co., argue that any hedge fund rating should be viewed circumspectly because it will be only as good as the analyst behind it and the analyst might not be well informed in the ﬁrst place. If he or she knows so much 42 • INSTITUTIONAL INVESTOR’S ALPHA • DECEMBER 2008/JANUARY 2009

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - December 2008

Institutional Investor's Alpha Magazine - December 2008 Contents Letter from the Editor Longs & Shorts Inside the Trade Pension Corner The Good Guys Interview: Stanley Fink Cover Story: The New Regulatory Reality United States: The Usual Suspects Europe: Flirting with Unity Asia-Pacific: What Asian Contagion? In Theory In Focus Strategies Research Center Alpha Bytes Unhedged Commentary

Institutional Investor's Alpha Magazine - December 2008

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