Moody’s to rate hedge funds

Anyone who’s watched a hedge fund blow up has asked the question: should investors have seen it coming? Gary Witt, a senior vice president and credit officer at Moody’s Investors Service, certainly has and the answer, more often than not, is yes.

Come April, investors may not have to ask that question as often. Moody’s is set to start providing hedge fund ratings, similar to the debt ratings the firm currently issues.

The new service flows from the intense investor demand on risks associated with hedge funds. Several funds have expressed interest in the service, but only one so far is prepared to submit itself for assessment. The hope is investor interest in this type of service will encourage other hedge funds to seek out ratings.

Although investors will welcome the ratings, Witt can’t guarantee a hedge fund still won’t fail if it’s been rated. Looking back on the recent hedge fund failures, about 10% or 20% of the cases had no clear warning sign, he says.

That’s not to say investors can’t be better informed. Witt found in two-thirds of the cases where funds have failed, a simple background check would have steered investors away from those funds. “People were lying in their own marketing material,” says Witt, who is heading up this project for Moody’s. “They were making claims that were not true that you could have verified.”

While Witt is still working on the final details of his methodology, he will focus on two main operational traits: first whether the valuation process is up to market standard and to make sure the hedge fund has checks and balances in place to protect against fraud.

“You can never guarantee that a hedge fund is not going to have some kind of fraud involved,” he says. “What you can do is make sure you is you can look to see if they have certain controls in place to make it a lot more difficult for that to happen.”

For instance, Witt explains, hedge funds could require multiple signatures for payments, have an established auditing firm go over its books and have an administrator who is heavily involved and able to answer questions from someone from Moody’s.

Witt adds that although he hasn’t thought of a specific strategy to rate Canadian hedge funds, he won’t be excluding them.

Similar to Moody’s debt rating service, it will be left up to hedge funds to pay for the assessment and to decide if they want to make that rating public.

Amber Partners, a newly launched Hamilton, Bermuda-based operational risk certification firm, provides a similar due diligence service to hedge funds. At the funds’ expense, the firm will perform a comprehensvie operational review. Like Moody’s, hedge fund managers will retain control over the report Amber Partners creates.

So far the firm, which is headed by two University of Alberta-educated women, has reviewed 10 hedge funds, including one that is currently under review.

Filed by Mark Brown, Advisor.ca, mark.brown@advisor.rogers.com

(02/27/06)