By Michael Beck, CIPM, CFP (R), Vice President, Glenmede Trust Company.
One of the main issues when adding hedge funds to a portfolio is the timing of reports. Hedge funds and other non-liquid alternatives tend not to be priced quickly after the month end. This can lead to an issue in reporting performance to the clients. The most common way for performance reporting is to provide the marketable returns quickly after month end and then wait until the alternatives are priced and backdate them to the correct time period. This can cause some headaches for the portfolio manager who is then unable to report the total account return to the client until 30, 45, or more days later to the client.
One possible solution to this issue is to lag the non-marketable returns by one month. For example, all of the equity, fixed income, and cash assets would be reported at the current month end, while the hedge funds and non-liquid alts would be reported based on the prior months’ data. (-1 Month). This allows the portfolio manager report to the end client on a timely method but can cause issues in clearly explaining the methodology to the client. The other issue that arises with this methodology is that the performance returns can be skewed if there are sharp movements in the markets that are occurring month to month. If the hedge funds are lagged, and the equity and fixed markets move significantly higher but the lagged hedge fund returns are lagged, and are negative for the previous month, this will not accurately report the performance return of the current month.
Another possible solution is to apply an estimate of the hedge fund or non-liquid alternative to the account and then make a true up calculation once the official return is updated. One road block with this approach is obtaining an estimate from some hedge fund firms for the prior month. Also, the initial returns that are reported to the client are preliminary can end up changing once the hedge fund returns are finalized. This can cause issues if the final pricing of the non-liquid alternatives becomes delayed by more than a month because the reports might not clearly show which of the prices were final.
In summary, there does not appear to be a standard methodology for the hedge fund and non-liquid alternative pricing and reporting issues industry wide. Please keep in mind all of the reporting and performance measurement issues that may arise prior to adding these types of investments to your portfolio.
To meet Michael Beck and learn more about this topic, attend the FTF Performance Measurement Americas Conference, March 8-9 in New York.
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