In early 2013 the CFA Institute announced Philippe Jorion and Rajesh K. Aggarwal won the Graham and Dodd scroll award from Financial Analysts Journal for their paper, “Is There a Cost to Transparency?” An in-depth interview with Professor Jorion appears in the June 2013 issue of The Analyst, the member bulletin of the CFA Society Toronto. Below are a few of the statements from the course of the interview.
Q: What is your principal area of research?
PJ: Ever since I discovered the field of finance, I have had long-standing interests in topics such as portfolio construction and risk management. My PhD thesis at the
Q: When did you become interested in issues connected to hedge funds? Was there a precipitating event that first drew your interest?
PJ: Actually, all of these topics (portfolio construction, risk management, and hedge funds) are interwoven. A particular example of risk mismanagement at a hedge fund was Long-Term Capital Management (LTCM). As most people who were working in capital markets in 1998 recall, LTCM lost $5 billion over a very short period of time (at that time, this was a lot of money.) I wrote a paper that explained the flaws in LTCM’s risk measures. These conclusions were relevant, obviously, to how other hedge funds were managing their risk.
Q: How would you characterize the current levels of (non)disclosure of hedge funds?
PJ: First, we should distinguish between public and private disclosure of positions. Public disclosure, such as the SEC’s 13F form that institutional money managers use to disclose long equity positions to the general public, is more than adequate. Revealing more detail on positions could cause harm to hedge funds and their clients, in my view. However, hedge funds should provide more information privately to their investors and regulators. In particular, private disclosure to investors has been woefully inadequate in my opinion. I can’t think of many industries where the client gives a blank check to his or her agent, essentially giving up the right to have any information about what they are buying. The maturation and institutionalization of the hedge fund industry, however, is slowly forcing hedge funds to reveal more information to their clients.
Q: Do you think the current levels of (non)disclosure of hedge funds poses a risk to financial markets?
PJ: In most cases, no. The hedge fund industry is very dispersed, with a multitude of funds that take a variety of positions. Compare that to the banking industry, which is highly concentrated and where broad exposures are similar. Leverage for banks is also much higher than for nearly all hedge funds. This explains why the banking sector was a major contributor to the recent credit crisis. Before the crisis, regulators thought that hedge funds posed major risks to financial markets. This view has now evolved. For example, the
Q: Do you anticipate a move by regulators to require more information from hedge funds?
PJ: In some cases, unfortunately yes. We are witnessing in
Q: Your paper is “the first study to directly examine the costs of private transparency.” What gave you the insight for how to properly compare transparent and non-transparent funds?
PJ: A recurring question is whether requiring private transparency could impose a cost to the investor. The argument is that this creates a selection bias in which only poorly performing funds are desperate enough to offer transparency. This is an interesting story but, like many well-known urban legends, has no foundation. Given my academic propensity for facts, I thought that this argument should be subject to empirical verification.
Q: Your paper notes that “interest in MACs has grown sharply” since 2008. What is the most attractive feature of MACs and why? What is the biggest drawback?
PJ: Investors were pretty unhappy about commingled funds during the 2008 crisis, and with good reason. Investors in commingled accounts were subject to the behavior of other investors in the same funds, some of whom panicked and redeemed at the worst possible time. In many cases this led to forced selling of positions, which hurt the remaining investors in the fund. This is what we call co-investor risk. In addition, many hedge fund managers exercised their right to “gate” the fund, or to suspend redemptions. This was sometimes for good reasons but often was not. In contrast, managed accounts offer complete control over the investment to the investor or a third party. In addition, they can be designed to suit investor preferences. Finally, they offer complete portfolio transparency. The main drawback of managed accounts is the need for a size large enough to absorb the fixed costs of operating the fund. ª
To read more about the Costs of Transparency for Hedge Funds, please turn to the original article in the Financial Analysts Journal. ª