Any attempt to regulate the hedge fund industry should focus strictly on sales practices and transparency, rather than tying the hands of the funds’ managers, and the industry should welcome it, according to one well-known author in the field.

“I think there will be more transparency on funds and how they can be moved, so that if the regulators want to see, they can see what is happening to the money,” says Peter Beck, co-author of Hedge Funds for Canadians, a primer on hedge funds for the general public. “As for how the fund should invest, I think that’s a fundamental advantage of hedge funds that as far as investing is concerned — they’re unregulated. That should be left to the independence of the manager.”

Already the U.S. Securities and Exchange Commission has introduced measures to track capital flows in hedge funds more closely, and Beck says similar measures are likely to be adopted in Canada as well.

In the case of Canada’s most high profile hedge fund investigation, it is still not immediately clear it the fund itself was corrupt. Investigators have been puzzled by Portus’ structure, which moved investor capital into offshore accounts. Only recently have regulators charged the firm’s leaders with improper use of investor capital.

The OSC’s investigation into Portus has turned the company into a household name in Canada, in turn tarnishing the hedge fund industry to an extent. It didn’t help when Norshield came under scrutiny as well. But Beck says such occasional regulatory issues prove to the public that they are being protected.

“The OSC stepping in and cleaning up is definitely a good thing — it gives the public a comfort level,” he says. “Every industry could attract one or two bad operators. That just happens, not just in the hedge fund industry, but in any industry. That doesn’t mean the whole industry is bad. Eventually those one or two bad guys get caught and that’s the end of it.”

A cleaner image could help the industry expand, as the Canadian market is dramatically lagging the U.S. By some estimates, there are over $1 trillion dollars in assets under management south of the border. Conventional wisdom places Canadian capacity at one tenth of the U.S. market, at about $100 billion, but Beck says Canadian hedge funds have yet to reach a fifth of that target.

“There are no hard numbers because you just don’t have the transparency in hedge funds that you have in mutual funds,” he says. “We can only estimate how much we have, but we don’t have $20 billion. There’s a huge upside [potential] here.”

Among the most popular hedge fund products are funds of hedge funds, which bundle together various funds following different styles and strategies, but these often face criticism over their higher fees.

Beck points out that most of the general public will spend more time researching a $500 stereo than they will on a $20,000 investment, worrying that prolonged deliberation will see them miss the boat.

“That’s why there is an extra level of management fees: one at the hedge fund level and another at the fund of hedge funds level,” he says. “You pay an extra layer hoping that the manager is doing their homework. Most of them are, but sometimes you have those bad ones … and they don’t work out that way.”

Of course, an advisor well versed in the hedge fund market should be able to help clients avoid such perils. Beck says there is no excuse for financial professionals to plead ignorance in the field, with a variety of courses, seminars and continuing education opportunities available.

“It is really best [for investors] to talk to a professional financial advisor who really knows what they are doing, to come up with the right mix for a given time for an individual.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(10/14/05)