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

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Latest Updates

Superannuation

The 'Contrast Principle' used by super fund test failures

Rather than compare results against APRA's benchmark, large super funds which failed the YFYS performance test are using another measure such as a CPI+ target, with more favourable results to show their members.

Property

RBA switched rate priority on house prices versus jobs

RBA Governor, Philip Lowe, says that surging house prices are not as important as full employment, but a previous Governor, Glenn Stevens, had other priorities, putting the "elevated level of house prices" first.

Investment strategies

Disruptive innovation and the Tesla valuation debate

Two prominent fund managers with strongly opposing views and techniques. Cathie Wood thinks Tesla is going to US$3,000, Rob Arnott says it's already a bubble at US$750. They debate valuing growth and disruption.

Shares

4 key materials for batteries and 9 companies that will benefit

Four key materials are required for battery production as we head towards 30X the number of electric cars. It opens exciting opportunities for Australian companies as the country aims to become a regional hub.

Shares

Why valuation multiples fail in an exponential world

Estimating the value of a company based on a multiple of earnings is a common investment analysis technique, but it is often useless. Multiples do a poor job of valuing the best growth businesses, like Microsoft.

Shares

Five value chains driving the ‘transition winners’

The ability to adapt to change makes a company more likely to sustain today’s profitability. There are five value chains plus a focus on cashflow and asset growth that the 'transition winners' are adopting.

Superannuation

Halving super drawdowns helps wealthy retirees most

At the start of COVID, the Government allowed early access to super, but in a strange twist, others were permitted to leave money in tax-advantaged super for another year. It helped the wealthy and should not be repeated.

Sponsors

Alliances

© 2021 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. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). 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.

Website Development by Master Publisher.