From Mario Mantrisi, Chief Strategy and Research Officer at KNEIP
The Alternative Investment Fund Management Directive (AIFMD) is just around the corner and hedge funds have been faced with adapting to regulation that is significantly changing the way they do business.
Transparency reporting has been a particular hurdle to pass as hedge funds have traditionally been more opaque than other investment vehicles. It has been a significant step change and managers must now develop plans for how to disclose information to their investors.
This has led to the question: should hedge fund managers follow the lead of traditional fund managers by adopting a Key Investor Information Document (KIDD) for the AIFMD?
The argument for adopting a KIID (a pre-contractual product disclosure document remitted before investors buy a fund) is that reporting to investors can be a complex and potentially costly affair. While some hedge funds have been disclosing data for years as the industry began a more general move towards greater transparency, this has not been a uniform or standardized practice and the AIFMD sets a higher standard of reporting.
Consistency in Reporting
A KIID-style document would also provide a level consistency in reporting that institutional investors require. Backers of hedge funds tend to have a number of different managers in their portfolios in multiple locations using various languages and so any information provided must be particularly clear and uniform.
Without a consistent method of providing data, any disclosure can actually be confusing and unhelpful; however, at the same time the solution to this problem also needs to be cost-effective for the fund managers themselves.
Implementing new regulation has involved delicately balancing the need to offer protection to investors, while preventing unnecessary negative impact on an industry that is already facing unprecedented cost pressures due to ever more wary investors.
The KIID has already proven to be an efficient solution. Such documents have been used to great success by asset managers under the UCITS framework and have now become a recognized standard for industry reporting to investors.
The successful implementation has been such that the European Commission has announced plans for a variant of the KIID to be extended to packaged retail investment products in 2015. But how would a KIID-style document fit into the AIFMD rules?
The European Securities and Markets Authority (ESMA) have not prescribed exactly how hedge fund managers should provide their data to investors under the Directive, so the opportunity is wide open for the industry to decide how they want to do it.
Some managers intend to use their normal fund prospectus documentation, but this is a relatively inflexible method that could become problematic for firms that run multiple vehicles that fall under the scope of the Directive.
Investors will require regular updates regarding any changes to each underlying hedge fund they have exposure to and therefore a KIID-style report could be a more flexible and efficient option as it could easily be re-tailored.
In addition, many of the initial teething problems that can accompany new rules regarding transparency could be avoided by using a KIID, as it has already been “road-tested” by the traditional fund management industry. The document as it stands now is the result of all the experience of traditional managers getting to grips with similar transparency standards under UCITS.
Hedge funds would also be able to take on board the lessons learned when developing the best and most efficient reporting processes, infrastructure and technology. Existing solutions for easing the burden of data collection and automating report production that were developed for the traditional fund market can simply be adapted and reapplied.
This would help cut down on the time and resources spent on learning on how to best solve the issues around updating reports, translating them into the necessary languages and distributing them to investors.
Of course, the traditional and alternative fund management industries are different and this would mean that using a KIID under the AIFMD would require some adaptation, but this would be minor changes.
Critics will say that there is a gap of sophistication between retail investors and the institutional and ultra-high net-worth investors that tend to buy alternatives funds. But regardless of levels of sophistication, any investor appreciates data that is disclosed in a clear, simple and detailed way.
The hedge fund industry will naturally find its own solution to the challenge of reporting to investors under the AIFMD, but it could do far worse than adopt a KIID-style document.