06 September 2005

AFM: Transparency of hedge funds a cause for concern

The Dutch financial regulator AFM says hedge funds’ lack of transparency is a cause for concern, and that investors don’t have enough understanding of the funds’ investment policies and risk profiles. In an “exploratory study of conduct-related issues” on Hedge Funds the AFM identifies a number of risks attached to the rapid rise of these funds.

The AFM identifies the lack of transparency as a key area of regulatory concern, and also calls into question whether fund managers themselves always have sufficient understanding of the investment policies and the risk profile of the hedge funds in which they invest.

It also said pension fund activity in the asset class may have an impact on market volatility. AFM argues that pension funds’ considerable allocation to hedge funds “indirectly exposes a much broader section of the public to this investment category”. “Consequently, the potential risks associated with these products are becoming relevant to a growing and more vulnerable part of the investor population.” The AFM noted that pension funds were investing in hedge funds in an effort to diversify and boost returns. “What seems clear is that hedge funds will increasingly depend on institutional investors for their capital. Some market watchers believe that in few years time pension funds could account for as much as half of all hedge fund inflows.”

According to the AFM, there is currently no compelling case to introduce measures specifically targeted against hedge funds. Although the AFM sees no pressing need for more regulation or tighter supervision, a follow-up investigation is to be carried out at a number of institutions.

Besides the risks the AFM also points at the positive effects of hedge funds. For example, the activities of hedge funds can contribute significantly to improving the efficiency of the market, e.g. by providing liquidity.

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