Hedge funds fear dead hand of the box tickers

By Laurence Fletcher

MONACO | Thu Jun 23, 2011 1:09pm EDT

(Reuters) - The entrepreneurial spirit that fueled the growth of the hedge fund industry could be killed off by investors worried about another Bernard Madoff-style fraud, said executives meeting in Monaco this week.

Managers left the GAIM conference, the annual get-together for the European industry, in more upbeat mood than last June after a year of client inflows, but they warned rigid demands by institutional investors threatened hedge funds' reputation as maverick investors.

"Institutions now are looking more for risk managers than investors, and that's a bad trend," said Oscar Schafer, managing partner of O S S Capital Management.

Executives said many big institutions, which helped hedge funds recover from the crisis of 2008, are now focusing their attentions on a checklist of attributes a hedge fund must have, such as a chief risk officer, a certain level of disclosure or a demonstrable investment process.

Not only can such demands distract managers from the task of managing money, but they may still not pinpoint the real risks and may mean that genuinely talented managers get starved of capital, managers warned.

"We have to encourage greater transparency ... But I think sometimes investors do go to the extreme, pushing 'check the box' style of risk management, which loses sight of where risks really do lie," said Coast Sullenger, managing director of Gaia Capital.

"Unfortunately, that type of approach does have a bad effect on entrepreneurial spirit, because it ties up managers to deal with those kinds of questions, and it's a big diversion."

MISSING THE NEXT SOROS

Institutional investors such as pension funds and endowments were among clients to back hedge funds during the credit crisis, when investors withdrew almost $300 billion net in 2008 and 2009, and now account for two-thirds or more of the $2 trillion industry.

But many are wary of a repeat of Bernard Madoff's fraud -- which delegates were reminded of when his yacht "Bull," up for sale at 3 million euros, was shown off at the conference this week.

While executives acknowledge that rigorous checks on a hedge fund's infrastructure and business model can help reassure investors and can help a start-up manager get their business in order, it can also go too far, they say.

"It's a game of protecting one's backside. A lot of employees are looking at those kind of personal risks, which would lead them not to invest in some particular companies."

Managers also worry that hedge funds could end up more like the traditional asset management industry and may not be able to take the same investment risks, meaning the most talented managers may never be spotted by investors.

"The last thing we want is to become a bureaucracy," said Bernard Oppetit, chairman of hedge fund firm Centaurus Capital. "It's a fact that the best investment decisions are the hardest to make, and they are almost never made by a committee."

"To tick every box on the part of investors is the wrong way to go. Of course they need to do due diligence, they need to kick the tires to make sure the infrastructure is robust ... but if this is all you do, you will not find ... the next George Soros."