By all accounts, hedge funds are having a great year. According to the Wall Street Journal, fund managers added a net $26.32 billion of new cash in the first quarter, the highest in almost three years. Better yet, many believe that there is a lot of room for growth.
Because a number of mature funds are no longer accepting new investors, it is a great time for hedge fund startups. Almost 300 new funds launched in the first quarter of 2014, which were spread across all strategies, and the prognosis for the remainder of the year is optimistic.
In the post Dodd-Frank era, many hedge funds are now subject to regulatory oversight, and the new compliance environment requires additional infrastructure and resources. Most managers must register with the SEC and comply with a host of new reporting and recordkeeping requirements. While some consider the heightened standard as a serious barrier to entry, many of the successful funds see it as a selling point. After all, the new transparency instills confidence in the industry, demonstrates an emphasis on investor protection, and boosts trust on the part of potential investors.
So, rather than fighting the facts, make the best of them. That means making compliance a way-of-life and weaving it into the very fabric of the fund’s operations.
A few key points:
Build a strong foundation and use the right tone from the top: It is tempting to start with templates, which are problematic on different levels. It is imperative that a fund tailors its policies and procedures to its business and operations. This will save a lot of time and resources in the long run, with the SEC and otherwise. The SEC’s biggest concern is that the industry lacks an understanding of the basic principles of being a fiduciary. Familiarize yourself with them, and set the tone from the top. This will take you a long way.
Assemble the right team: The team should match the size and complexity of the fund, and may include accountants, attorneys, and other experts who are familiar with the regulatory requirements. For smaller funds, it may just mean appointing a Chief Compliance Officer who wears more than one hat. Regardless of size, all compliance personnel should be dedicated and knowledgeable, i.e. well-trained.
Monitor, test and keep it current: Compliance is not a one-time affair. Changes in the business, market dynamics, regulatory environment etc. occur frequently and fast. You snooze you lose. Policies and procedures, internal controls, records and staffing need to be reviewed and re-considered regularly and modified as appropriate. Moreover, periodic testing is crucial for determining the viability of a compliance program.
I have no doubt that funds who strategically adapt to the new environment will strive, or at least they will not falter because of enhanced compliance requirements. Work with what you’ve got and take advantage of market dynamics. If you would like to learn more about the brave new regulatory world post Dodd-Frank, watch out for my book, which should hit the shelves in early fall.