Market turmoil leads to operational stress at hedge funds

Market-related pressures due to the ongoing credit squeeze and the loss of investor confidence also place operational stresses on the hedge fund industry, rather than just financial stresses, Moody's Investors Service said in a new report.
"The financial underperformance of many hedge funds in the current economic downturn may itself be symptomatic of latent deficiencies in a hedge fund's operational infrastructure, which is typically organized around the goal of avoiding such outcome," said Teresa Wyszomierski, author of the report. "The industry is also struggling to cope with record redemptions, as nervous investors react to bad news or seek to cover losses incurred elsewhere."
She said poor performance may lead to unusually high redemption activity, creating pressure to invoke gates or suspend redemptions entirely. Elevated redemptions also raise the importance of the valuation processes at a time when market illiquidity can make it difficult to obtain independent corroboration of fair values. Moody's considers valuation to be among the most critical operational processes for a hedge fund.
"Even if a fund's staff, processes and systems are performing as expected, at some point the financial distress associated with a protracted economic downturn raises the risks of senior staff turnover, management distraction, and disruption of risk management or other operational processes," said Wyszomierski.
"However," said Wyszomierski, "because hedge funds have varying structures, occupy different market niches, and exhibit widely divergent performance, Moody's ongoing assessments in this area will take into account the specific circumstances of the individual funds in question."