Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 38

ASIC’s focus on hedge funds may miss bigger picture

After a long consultation period, ASIC has amended its regulatory guidance relating to hedge funds (RG240) to focus on “… those funds that pose more complex risk to investors”. I discussed ASIC’s previous version on improving hedge fund disclosure in Cuffelinks on 1 April 2013. Many others raised concerns, with the prize for the most colourful title going to Mallesons with their, “Who’d be a hedgie? Could new reforms regulate hedge funds out of existence?”

Since then, ASIC continued to extend relief from the disclosures required under RG240 and in October 2013 released an updated version, to commence from 1 February 2014. ASIC Commissioner Greg Tanzer was quoted as saying, "Our changes will benefit the industry by relieving some lower-risk funds from the more extensive disclosure obligations imposed on a hedge fund under RG 240." From this comment the intention of the disclosure is evident: to create more extensive disclosure obligations for hedge funds, thereby protecting potential investors.

Revisions in ASIC’s updated version

What are the changes? The updated version of RG 240 makes only subtle changes to the definition of a hedge fund, in response to feedback from some groups that want to avoid this label. The broad definition of a hedge fund remains (full details here), namely a fund which promotes itself as a ‘hedge fund’ or one that exhibits two or more characteristics of hedge funds, the five characteristics being: complexity of investment strategy or structure, use of leverage, use of derivatives, use of short selling and charging of a performance fee.

The changes in the updated RG240 only apply to the descriptions of these characteristics:

  • under the characteristic of ‘complexity of investment strategy’, benchmarking to a blend of traditional market indices (such as traditional multi-asset class funds) is now excluded as a characteristic of a complex investment strategy
  • under ‘complexity of structure’, ASIC has clarified the definition of interposed entities (ASIC views too many interposed entities involved with the end product as a characteristic of a hedge fund) to relieve those parties using an authorised investment vehicle in a foreign jurisdiction
  • under ‘use of derivatives’, ASIC now does not consider the use of exchange-traded derivatives where the notional derivatives exposure does not exceed 10% of a fund’s net asset value as a defining characteristic of a hedge fund.

Extra disclosures for ‘hedge funds’

As discussed in my previous article, if a fund is deemed to be a hedge fund then it faces more significant disclosure requirements in the areas of:

  • investment strategy: detail of the strategy, exposure limits
  • investment manager: increased disclosure around key staff, qualifications, background, employment contracts
  • fund structure: detailed disclosure around the structure of the fund and service providers, and fees through the structure
  • custodial: valuation, location and custody of assets, custodial arrangements, and a list of all instruments and markets traded
  • liquidity: description of liquidity policy and any illiquid positions
  • leverage: disclosure of leverage and possible ranges
  • derivatives: a fair amount of disclosure required
  • short selling
  • withdrawals: disclosure around withdrawals and associated risks.

These areas of disclosure are what ASIC calls benchmarks and disclosure principals. ASIC advises that every PDS for a hedge fund should meet these disclosure requirements. However a responsible entity can adopt an ‘if-not-why-not’ approach where they do not disclose on a particular issue and clearly explain why they didn’t disclose and the risks this may create for investors. Of course ASIC may choose to not approve PDS’s with insufficient disclosure.

Will RG 240 work? If the objective of ASIC is to avoid repeats of the types of losses we saw with Astarra Strategic Fund and Basis Yield Alpha Fund, then RG 240 will assist but will not guarantee repeats of these events. ASIC’s model is to seek disclosure and then leave the rest to the (now presumed to be informed) investor. The investor can choose to use or not to use this additional information. Lack of investment knowledge and the behavioural biases that exist in investing will undoubtedly ensure future disasters.

What are some of the consequences?

Financial planners may ‘discover’ they have clients invested in hedge funds. Do they have to change their Statement of Advice? Will PI (professional indemnity) insurance bills be higher for financial planning groups which include hedge funds on their approved products list? If they change client portfolios as a result, there may be capital gains tax realisations.

The underlying hedge fund managers will be most affected. Some of the disclosures affect their ability to run their business (for instance they have to list key people and outline some details of their employment contracts), raise assets (the financial planning community may be deterred from recommending hedge funds) and protect their investment strategy (disclosure of instruments and use of leverage may give competitors some insight as to their strategy). I am not overly concerned about any changed perception of the hedge fund industry – it is full of complex products.

My main concern is that the term ‘hedge fund’ is used as the parking bay label for complex investments. The complementary set of investment products to those defined as ‘hedge funds’ will contain many investments which are complex. People may incorrectly regard investments which are not hedge funds as not being complex. Consider just a few: geared share funds, the range of equity income funds that use derivatives, new-age total return balanced funds, the more flexible fixed income and cash funds, the list goes on ... There are complex funds all around yet they may not be labelled as a hedge fund.

Better to focus on ‘complexity’

In my submission to ASIC for RG 240, I suggested that instead of focussing on hedge funds there was a one-off opportunity to focus on investment product complexity itself. Instead of defining hedge funds, ASIC could define complexity (for example a ‘complex’ investment may only require one of the five characteristics listed above), and disclosures appropriately designed. Funds could then label themselves as they like and ‘hedge fund’ would not be held out as the area where all the complex investments funds reside.

This type of approach would take the stigma out of complexity. These ‘complexities’ are usually used for a positive reason – to enhance returns or manage risks - but also highlight that extra consideration is required by investors. Investors would become more aware that many products have elements of complexity to them. It would also reduce ‘regulatory arbitrage’ where the provider designs a product to avoid being caught under particular regulations. Finally, as new products and categories are created, there is an over-arching definition of complexity that would catch these products rather than ASIC having to develop specific guidance.

Overall, while RG 240 will assist investors to be more aware when they are considering a hedge fund investment, I can’t help but feel it is an opportunity lost in terms of the bigger picture of investor protection in a world of complex investments. 

 

David Bell’s independent advisory business is St Davids Rd Advisory. David is working towards a PhD at University of NSW.

 

RELATED ARTICLES

How ASIC defines ‘hedge funds’ and what it means to you

Respect for markets and judging HFT

Hedge funds no systemic risk to financial system

banner

Most viewed in recent weeks

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

The nuts and bolts of family trusts

There are well over 800,000 family trusts in Australia, controlling more than $3 trillion of assets. Here's a guide on whether a family trust may have a place in your individual investment strategy.

Welcome to Firstlinks Edition 583 with weekend update

Investing guru Howard Marks says he had two epiphanies while visiting Australia recently: the two major asset classes aren’t what you think they are, and one key decision matters above all else when building portfolios.

  • 24 October 2024

Warren Buffett is preparing for a bear market. Should you?

Berkshire Hathaway’s third quarter earnings update reveals Buffett is selling stocks and building record cash reserves. Here’s a look at his track record in calling market tops and whether you should follow his lead and dial down risk.

Preserving wealth through generations is hard

How have so many wealthy families through history managed to squander their fortunes? This looks at the lessons from these families and offers several solutions to making and keeping money over the long-term.

A big win for bank customers against scammers

A recent ruling from The Australian Financial Complaints Authority may herald a new era for financial scams. For the first time, a bank is being forced to reimburse a customer for the amount they were scammed.

Latest Updates

Shares

Looking beyond banks for dividend income

The Big Four banks have had an extraordinary run and it’s left income investors with a conundrum: to stick with them even though they now offer relatively low dividend yields and limited growth prospects or to look elsewhere.

Exchange traded products

AFIC on its record discount, passive investing and pricey stocks

A triple headwind has seen Australia's biggest LIC swing to a 10% discount and scuppered its relative performance. Management was bullish in an interview with Firstlinks, but is the discount ever likely to close?

Superannuation

Hidden fees are a super problem

Most Australians don’t realise they are being charged up to six different types of fees on their superannuation. These fees can be opaque and hard to compare across different funds and investment options.

Shares

ASX large cap outlook for 2025

Economic growth in Australia looks to have bottomed, which means it makes sense to selectively add to cyclical exposures on the ASX in addition to key thematics like decarbonisation and technological change.

Property

Taking advantage of the property cycle

Understanding the property cycle can be a useful tool to make informed decisions and stay focused on long-term goals. This looks at where we are in the commercial property cycle and the potential opportunities for investors.

Investment strategies

Is this bedrock of financial theory a mirage?

The concept of an 'equity risk premium' has driven asset allocation decisions for decades. A revamped study suggests it was a relatively short-lived phenomenon rather than the mainstay many thought.

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.