The hedge funds sector is starting to move toward getting public rating, motivated in part by mitigating fears of counterparty risk. Nevertheless, counterparty ratings by Standard & Poor's and Fitch Inc., as well as ratings of the hedge funds themselves by Fitch, can provide the greater openness for which institutional investors are looking.
Non-traditional hedge fund investors, such as pensions, foundations and endowments, have been upping their allocations, but require more transparency. And what better way for a manger to pitch their fund than to says, "I have an investment-grade rating from Fitch," says an industry consultant. Indeed, the debacle of Long-Term Capital Management coupled with recent incidents of fraud has led hedge fund managers to open up in ways they never have before, says John Schiavetta, a managing director at Fitch. Jonathan Ukeiley, director in the financial institutions group at Standard & Poor's, agrees with Schiavetta, noting that he has seen the demand for ratings increase as of late.
The S&P rating is to assess counterparty risk and should not be used by investors to interpret past or future performance, said Ukeiley. It takes into consideration a hedge fund's asset composition, risk profile, strategy, liquidity and use of leverage, among other factors. For the most part, these ratings are not released to the public and are only disclosed to the hedge fund and its counterparties. Still, the hedge fund could show the rating to a potential investor as some evidence of the manager's financial health. "If you have an investment-grade rating to show around, that could help make investors more comfortable," Ukeiley explains. Fixed-income hedge funds that depend on Wall Street dealers for credit to fund securities purchases have sought counterparty ratings to help ensure that financings won't be pulled if financial markets suddenly take a dive.