We spoke recently with Mark Casella, U.S. Alternative Investments leader at PricewaterhouseCoopers. Casella, also the chair of the accounting advisory committee of the Managed Funds Association and a member of the Board of Advisors of the Georgetown University McDonough School of Business, seemed the ideal partner especially in light of the recent publication of PwC’s white paper on the hedge fund industry, (which we summarized in late June), for a wide-ranging discussion of that industry’s structures and opportunities.
The discussion breaks down naturally into two parts: market structures first, (Part One), then the question of the alignment and re-alignment of the interests of managers and investors (Part Two, below).
Q: Do you see, as part of that alignment or realignment of interests, the withering away of redemption gates and suspensions, which were a notorious root of investor grievance during the financial crisis?
A: Nobody ever wants to put gates up or to announce a suspension. When we look at start-ups, we see that gating and suspending powers have been modified. These contract provisions won’t go away, but they are open to change. Endowments and pension funds in particular don’t want their money tied up; they have to ensure that their income is matched to their liabilities. One of the ways hedge funds can build trust is by showing that they are aware of this. It’s another form of alignment of interest.
Q: Which of these is most likely to keep an investor awake at night: (1) the thought that he’s entrusted his money to a Madoff or Peregrine? (2) concern that he has made a misguided choice about strategy or managerial competence, or (3) worries about the operational aspect of the HF industry?
A: The first of those, definitely. Beyond that, of course, investors are concerned about their return and want it to be reliable, want to limit its volatility and so forth. But the cause of insomnia? The first of those, full stop. As a result, the scope and intensity of operational due diligence that investors, or their consultants, perform has increased over the last 4 years.
Q: Do you think there are public perceptions that wildly leveraged speculators were responsible for the crisis? And, if so, do you think that will be driving the politics and regulations of hedge funds?
A: There was an image problem, and the industry has had to address the issue. I think that the situation has gotten significantly better. Personally, I think mortgage foreclosures and related problems had a lot more to do with the crisis than leverage or speculation, and I’m not sure how much of the public thinks otherwise. Regardless of what drives regulation, it’s clear that regulation is here and managers have embraced it through readiness assessments and increased compliance resources and infrastructure.
Q: Finally, during your time at PwC the hedge fund industry has changed in terms of its technology a good deal. There has been a move toward high-frequency trading, even in terms of microseconds, and algorithmic execution. Do you think people are right to be anxious about the effects of these developments?
A: The hedge fund industry will continue to evolve. Its entrepreneurial nature is one of its hallmark characteristics. The search for alpha through HFT may be one example of that but there are others. I don’t think there is outright reason to be anxious about HFT.
As we said in our recent Trust and Transparency paper, the industry has moved from being more opaque, a black box, to more transparent, an open book. The more a specific trading style is still a black box, which is one of the criticisms of HFT, the less transparent. Perhaps more transparency, in an appropriate way, about HFT could lessen some of the anxiousness that you refer to.