Almost everyone has a flashback childhood memory of being threatened with not getting dessert (or even dinner, in this author’s case) without cleaning up the old bedroom first. Make the bed, clear out the dirty socks and underpants and get the stray toys and other garbage off the floor, and you’ll get your “allocation.”

It is abundantly clear that any hedge fund manager interested in receiving an allocation from an investor these days needs to do the same thing: clean up their room, or at least clean up their back-end operations, the two most important issues being reducing counterparty risk (and risk overall) and increasing transparency – the socks and the toys, if you will.

How to do that for many managers is easier said than done. While many are responding to the lessons of the global financial crisis by implementing different kinds of operational improvements, it’s tough to know what kind of standard to apply, and even tougher to know what kind of standards potential investors are expecting.

Even so, managers are trying their best to beef up their operations, with a particular emphasis on reducing counterparty risk, improving reporting and transparency and in many cases securing independent firms to handle their valuations and accounting.

Indeed, according to a recent survey by Greenwich Associates and Omgeo (click here to download the full White Paper from Omgeo’s Web site – a short registration process is required), roughly 70% of hedge fund managers surveyed have already done something to spruce up their operations to reduce counterparty risk – boosting their cash accounts, outsourcing their valuation methodologies to a third party and increasing the frequency and detail of their reporting to clients. (See chart below.)

Managers are also moving to revise policies and controls – a biggie on many a due diligence questionnaire. Most importantly, many are increasing the number of prime brokers they work with – 60%, according to the survey results – a move virtually all have done as a way to reduce counterparty risk. The chart below shows how counterparty risk concerns have pushed the majority of hedge funds to the “multiple-primes” format.

To be sure, the tables haven’t completely turned over post-crisis. A whopping 98% of respondents noted they have no plans to join a clearing house to further mitigate counterparty risk, choosing instead to still rely on their prime brokers and other agents to clear trades.

The trade-off to increased operational oversight, of course, is cost. Roughly one-fifth of the survey’s respondents have had to spend money to hire or upgrade internal operations staff, and more two-thirds noted their initiatives have required sinking more money into IT.

And what needs to be fixed and / or automated? Reconciliation, first and foremost, in addition to cash management, collateral management, pricing, accounting and reporting.

Still, most managers have already noted the benefits, namely being able to attract investors and assets.

Of course, there will always be managers who are seemingly too big, too successful and too well-allocated to bother with heightened operations standards that investors might expect. Likewise, there will always be investors willing to let their guard down and drop a few stipulations off the questionnaire because  the strategy is great, the returns even better, the manager is finally open, because their peers are already allocated and because they really, really want to be in the fund. (Read our previous post on the risk-reporting chasm still prevalent between managers and investors here.)

But if Greenwich / Omego’s sampling is any sort of reflection of broader trends underway, the bar is likely to end up resting a bit higher for both sides than it used to be, with no one worse for wear.

In other words, a world of cleaner, tidier bedrooms, and more dessert – having your cake and eating it too.

In spite of the obvious analogies between the current frigid weather in the US Northeast, we at AllAboutAlpha.com have long been intrigued by how one puts a dollar figure on a frozen asset.

Indeed, one thing no one has seemingly ever figured out (and conveyed publicly, to our knowledge) is what the assets frozen by Lehman Brothers’ 2008 bankruptcy might have been worth had hedge funds and others actually been able to take them out and sell them.

In a global market where everyone was tripping over each other for the exits, what would securities that on the books might have been worth something before September 15, 2008 were, at the time of Lehman’s failing, basically worth nothing? More…

If there’s one party investors are truly pining to get into this holiday season, it’s the counterparty. And if there’s a cool cat on the block that they’re hoping to hook up with to get them past the velvet rope, it’s the third-party risk management firm that can either provide them with the right tools to size up their counterparties or even do it for them.

According to a report published this week by research firm TABB Group, investors, particularly buy-side traders that work for them, are putting counterparty risk and managing enterprise risk at the top of their priority list for 2010. More…

See no ops risks. Hear no ops risks. Speak no ops risks.

Some 99% of investors and investment consulting firms are more concerned than ever about operational risk management, according to a survey conducted by operational and IT consulting firm the Glass Hammer and Stone House Consulting Group, LLC at a recent conference.

One has to wonder who the 1% “neutral” holdout is, based on the summary of the survey’s findings shown in chart form below.  Is that one person in 100 actively trying to avoid addressing any operational issues?  ‘Cause this isn’t a good way to go about it. More…

The illiquidity of alternative investments often used to explain their risk-adjusted out performance (see previous coverage on this topic  here).  But what if some of that risk adjusted out performance was actually the result of so-called “return smoothing”?  Critics of hedge funds suggest that hedge fund managers have an incentive to mis-report returns in order to make themselves look good.   Are the critics right?  And if so, is the “illiquidity premium” really just a result of the mis-valuation of illiquid investments?

These are the questions tackled by a new paper written by Gavin Cassar of Wharton and Joseph Gerakos of the University of Chicago’s Booth School of Business.  Cassar and Gerakos use a database of hedge fund due diligence reports (the same one used in this study) to measure the serial correlation of hedge fund returns across funds with different valuation policies.

The study contains a table that you might find interesting if you ever have to conduct due diligence on a hedge fund.  Reproduced below, it shows the percentage of funds in each hedge fund strategy that use each of several different NAV calculation sources: More…

Back in 2007, we told you about a paper (and subsequent presentation to CAIA’s Swiss Chapter by one of the authors) that explored the pathways followed by so-called “hedge fund contagion”.

Then, last August, we told you about a paper by John Dai and Suresh Sundaresan of Capula Investment Management called “Risk Management Framework for Hedge Funds: Role of Funding and Redemption Options on Leverage”.  In it, Dai and Sundaresan argue that a hedge fund essentially sells an option to each of its investors and lenders (e.g. prime brokers) since both parties are free to pull the plug on their support (although investors often face extensive waiting periods).

Now, a new working paper by Benjamin Klaus and Bronka Rzepkowski  of the European Central Bank called “Risk Spillover Among Hedge Funds” combines these two concepts by blaming hedge fund contagion on both investor redemptions and “tightening financial conditions” precipitated by prime brokers.

Being central bankers, the authors also propose several policy prescriptions.  So you may want to check out this report if you’re trying to forecast how the Europeans – and potentially the Americans – are going to tackle hedge fund regulation. More…

In case you hadn’t noticed, transparency is all the rage. Risk-value statements and look-through trades, transactions signed sealed and confirmed kosher by an arm’s length third party are what investors at minimum demand of their hedge funds in the post-Madoff and post-meltdown world.

What they are also increasingly demanding are not quarterly, monthly or weekly, but daily NAVs – and even then not just a number pumped out by the hedge fund’s interns each day, but a genuine, cross-referenced, triple-checked, rubber-stamped NAV, with a cherry on top.

The demand among investors and their underlying managers for independently valued and accurately produced NAV has placed new pressure on administrators, who until last year handled the middle- and back-office operations of hedge funds in much the same way an accountant handles books: Sure the numbers are right, based on the information I was given and not under any obligation to verify. More…

Galleons have always liquidated quickly

Wire-taps, sting operations and perp walks associated with insider trading allegations and money being funneled to terrorist camps in southeast Asia – all the makings of a John Grisham book, at least one with a financial and Wall Street versus legal bend.

Of interest to AllAboutAlpha.com, however, is that beyond the numerous shocking and not-so-shocking headlines, Galleon Group, which has been in business for more than 12 years and reportedly managed some $3.7 billion in assets, is winding down and shuttering its doors in the span of a scant 45 days.

“I have decided that it is now in the best interest of our investors and employees to conduct an orderly wind down of Galleon’s funds while we explore various alternatives for our business,” Raj  Rajaratam, the 52-year-old billionaire founder of the firm, wrote in a letter to clients.

It’s not so surprising that the firm is winding down. Indeed, as we hit “publish” on this piece, Galleon had already reportedly liquidated practically all of its holdings, mostly large-cap equities like Apple, Google and Bank of America, but also some not-so-liquid securities traded over the counter or in emerging markets. According to sources quoted by Dow Jones Newswires, the firm is on track to pay out investors by January 1, 2010 — at a profit. More…