Abdul Sheikh, CAIA, a Vice President at State Street's fund administration group, makes the case that many attendees of GAIM Ops also made: that independent fund administration may be the only way to fully address investor concerns in the post-Madoff world.  

Alternative Viewpoints: The Ascendancy of Risk Management

Special to AllAboutAlpha.com by: Abdul Sheikh, State Street Fund Administration

In the past years, investors used to select fund managers based on three criteria: performance, philosophy and pedigree. But in Deutsche Bank's annual Alternative Investment Survey released last month (see related post) , "risk management" entered the ranks of the top three selection criteria for the first time, and "pedigree" fell to fifth.

It's clear that we are witnessing a paradigm shift in manager selection and asset allocation criteria.   Gone are the days of just looking at attributes like track records, top down vs. bottom up approaches, low correlations to markets, and manager size.  Recent events have shown that investors need transparency, independent risk analysis, and independent asset servicing.

A State Street study conducted late last year in conjunction with the 2008 Global Absolute Return Congress (see related post) reinforces this - indicating that five out of six institutions (84 percent) expect more disclosure of hedge fund positions and nearly half (49 percent) anticipate more frequent reporting from hedge fund managers. Meanwhile, only a few (19 percent) currently receive some level of consistent transparency across hedge fund holdings.

Institutional investors may believe their portfolios are well diversified.  However, do they really know what their concentrations are and what these concentrations mean to them?   Depending on the strategy, the managers may be allowed to take on leverage, but only a thorough analysis can determine whether that leverage is accidental or deliberate (and thus beneficial to the overall portfolio).  However, this kind of thorough analysis usually requires position-level transparency.

Heightened concerns over transparency and risk management are increasing demand for independent asset servicing.  Functions such as securities processing, fund accounting, reconciliations, security settlement and safekeeping are no longer viewed as value-added but necessary. Many industry experts think that the Darwinian processes occurring for the past year will separate the "premier league" of funds from the others. Based on the result of the surveys above, these premier league funds will likely be distinguished by their ability to employ independent asset servicing, provide transparency and use better risk management systems.

To read more, please click here.