How do they hide their positions from their own employees? Also, on the broker side, how do they prevent the broker from disclosing the information or using it for themselves?
I don’t know how they hide from their own employees. As for brokers, I know that some use multiple brokers and mix up their orders so no one broker can see all of the trades.
Most hedge fund strategies aren’t the glamorous rocket science that many think they are, and hence their positions can actually be rather dull. Many, are just a mutual fund on steriods. Opps, I broker the HF code of secrets that jusitifies outrageous fees for products that don’t consistently beat the market.
CFA_Halifax can just bite me. Anyway, there are plenty of employees at hedge funds (i.e., the receptionist) who don’t need to know any positions and just can’t look at brokerage reports. If you hide a position from the risk manager for instance, there’s a serious problem.
Why would they want to hide their positions from their employees? Most people within the fund will need to have access to the positions for their day-to-day work as in any other asset manager. Any broker will have Chinese walls. Are they effective?? I’m - naively perhaps - quite convinved they are. Also, the average broker doesn’t care about the positions themselves, just about the specific deal he/she wants to do and the administration side. Above that they mostly use multiple brokers but hiding their secrets is not the main motivation for doing that.
JoeyDVivre Wrote: ------------------------------------------------------- > If you hide a position from > the risk manager for instance, there’s a serious > problem. If risk managers are not in the capacity to get the positions from an independent source but are fully dependent on the traders… they’re not getting my money! Risk management is very, very important in our due diligence.
So I’ll get sued for this. Suppose that you are a managed futures hedge fund charging 2/20. Most big managed futures funds hold their positions for weeks or months. Suppose that you took all of their trades and said that instead of doing them at the time the fund actually did the trades, what if you did them at the open on the next trading day. What do you think the result is and do you think that the difference, if any, is close to the 2/20 fees paid to the fund? Now suppose that the $40k receptionist had access to all the positions. If someone was otherwise going to invest $10M in the fund that should return say 20% before fees, they would expect to pay $400K in fees…
mcpass Wrote: ------------------------------------------------------- > JoeyDVivre Wrote: > -------------------------------------------------- > ----- > > If you hide a position from > > the risk manager for instance, there’s a > serious > > problem. > > If risk managers are not in the capacity to get > the positions from an independent source but are > fully dependent on the traders… they’re not > getting my money! Risk management is very, very > important in our due diligence. Better rethink that. There are plenty of ways a trader can hide a trade ticket at a hedge fund dealing with OTC stuff. A really important problem for a risk manager is to figure out process so that doesn’t happen but it’s a constant problem. Between you and me - I’ve worked very hard on that stuff but I lost a position once that was a forward contract on a to-be-issued stock because it was a trade with a single counterparty, not on any brokerage statement with no MTM, no cash flows, and a computer bug in commercial software dropped the position because the ticker wasn’t trading. On another occassion, it took me two weeks to find that we were sitting on a 6M loss on a T-bond futures though there were tons of checks from brokerage statements, accounting, trading etc. because a certain SOB trader was trying to cover his trading error. It's really hard to keep track of all this stuff. Edit: In some sense I was doing fine on the risk management on this occassion because I was aware of the position. I just wasn't aware that the position was supposed to be gone so there was no exit plan, no stops, etc.. Just for a much easier example - a bane of my life has been doing trade reconciliation of FX crosses. Suppose that you are trading 25 different currencies crosses with 6 different brokers and some of them list, say, BP/Yen as BP/Yen and some of them list it as BP/USD; USD/Yen. Now suppose that you are also trading Pound/Euro, Yen/Euro, /Euro, etc… At the end of the day, you do lots of checks that rely crucially on your traders. If a trader wants a trade to disappear, he can do it for awhile. It’s a good thing to explore on your due diligence though. If someone says, it can never happen you shouldn’t believe them unless they are trading very plain vanilla things with a single prime broker or something.
True. What we try and do is make sure the counterparty confirms every trade with the backoffice - or administrator preferrably for a small shop - directly. If a trader is in the middle of everything that’s an operational risk and you don’t get compensation for these kinds of things. It doesn’t have to be fraud necessarily or Jerome Kerviel style but everyone makes mistakes. When walking through the trade process as an outsider you just want to see the checks and balances and independent role. We’re not in a perfect world, though. Luckily because that’s what pays the check every month. PS. You should see the disclaimer in every due diligence report I write…
mcpass Wrote: ------------------------------------------------------- > True. What we try and do is make sure the > counterparty confirms every trade with the > backoffice - or administrator preferrably for a > small shop - directly. If a trader is in the > middle of everything that’s an operational risk > and you don’t get compensation for these kinds of > things. It doesn’t have to be fraud necessarily or > Jerome Kerviel style but everyone makes mistakes. > That’s good. Another thing to ask is about who gets to negotiate ISDA’s and what the process is for making sure that back office knows who all the counterparties are. Next time you do due diligence ask the risk manager if he has a list of all approved counterparties and then ask if there was any way that there could be a trade with anyone not on that list. It’s pretty tough to tell a trader that all counterparty agreements will first be vetted by risk management and legal because they will do the prima donna thing and tell you that it is too time-consuming and glorious trade opportunities will pass them by. > > When walking through the trade process as an > outsider you just want to see the checks and > balances and independent role. We’re not in a > perfect world, though. Luckily because that’s what > pays the check every month. > > PS. You should see the disclaimer in every due > diligence report I write…
That sounds familiar… We’ve seen a fund where risk and legal had to approve all counterparties. There was a nice form a trader had to fill out to ask risk/legal to add the cp to the approved list. When checking the actual approval system we found three instances where a deal was done and at the same time the form was sent to risk management to approve… of course they didn’t have an example of a counterparty they rejected nor did they have a clue when a counterparty would be approved or not.
I think you’re doing a good job on your due diligence. I’ve been there - then the risk manager walks down to legal and says “Who is KLH Securities in Boca Raton?” Legal shrugs. Risk manager walks to trader and says “Who is KLH Securities in Boca Raton?” Trader says “The person I just bought all those airplane leases from”. Then what?
If you have a waterproof system… call me! Good discussion, though, we only started to add HF’s to our portfolio last year as we were invested in FoF’s before then. It’s a lot more interesting to look at but there are always gaps you aren’t aware of. The last thing I need is a HF blowing up because of something I should have noticed.
mcpass, why did your company decide to directly invest in HF? Were you unhappy with FoF’s performance, fees, etc?
Let’s say Soros is bying XYZ stock and he spreads his order to multiple brokers. What’s preventing the brokers from using it and buying some of it for themselves? Or even disclosing the information to family, friends, or other third party people?
CFAdummy Wrote: ------------------------------------------------------- > Let’s say Soros is bying XYZ stock and he spreads > his order to multiple brokers. What’s preventing > the brokers from using it and buying some of it > for themselves? Or even disclosing the information > to family, friends, or other third party people? Nothing but it’s way worse than that. Suppose Soros wants to establish a huge position in a stock. His broker not only knows his positions, he knows his orders. Front-running your clients is illegal and it happens all the time. You wouldn’t believe the number of traders I’ve seen that think they are great traders because the front run flow on orders desks.
mcpass Wrote: ------------------------------------------------------- > If you have a waterproof system… call me! > > Good discussion, though, we only started to add > HF’s to our portfolio last year as we were > invested in FoF’s before then. It’s a lot more > interesting to look at but there are always gaps > you aren’t aware of. > > The last thing I need is a HF blowing up because > of something I should have noticed. It actually seem like you’re following the best advice I could give you. Don’t listen to the front man as he will tell you whatever he thinks you want to hear and doesn’t know anything anyway. Ask to speak to the risk manager, the compliance officer, the head of IT, the COO. You put the in a bad spot (probably) but you’ll learn more.
The brokerage firm doesn’t check for front running?
maratikus Wrote: ------------------------------------------------------- > mcpass, why did your company decide to directly > invest in HF? Were you unhappy with FoF’s > performance, fees, etc? It wasn’t my call but basically we had built up an exposure in HF’s that justified direct investment. On one hand you reduce fees because you deal with HF’s directly for amounts that the average FoF cannot compete with (so our fees are typically lower too). Also, HF’s like to have our name on their client list as it gives them an idea of being of ‘institutional quality’. Perhaps even more important than that is that we are not a direct threat to the HF’s in terms of their strategy so we have been able to push them for more transparency. Our market risk team gets position overviews on a daily basis so they can include them in the risk overview for our portfolio as a whole. It wasn’t their performance. That wasn’t too bad. We still use them to build up a reasonable exposure in our absolute return portfolio but for some strategies we like to have more exposure so why not deal with those funds directly.