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Christopher Sugrue Leading: Barrons Magazine

September 14, 2014

Features - Main

Opening the Kimono

A new Website offers a revealing view into the hedge-fund industry

 
Updated Feb. 14, 2000 12:01 a.m. ET

I n the fall of 1998, Christopher Sugrue was a nervous hedge-fund investor. The world's financial markets were in turmoil following Russia's surprise decision to default on its government bonds, but Sugrue was receiving assurances from his hedge manager that everything was okay. Two months later, the manager admitted he had suffered much bigger losses than had been disclosed.

Disclosure, or what the industry refers to as transparency, has become a hot issue for hedge funds. The lack of it has been blamed for every hedge-fund calamity, whether it was last month's blowup of Manhattan Investment Fund, the federal bailout of Long-Term Capital Management in 1998 or the collapse of Granite Capital in 1994. And transparency would certainly clear up the issues raised about the Maricopa Investment Funds in our cover story (King of Naples ).

While regulators and investors debate the need for more disclosure, Sugrue and his company, PlusFunds.com, may have come up with a free-market solution to the transparency problem. Two years and $25 million in the making, PlusFunds is using the Internet to provide investors with real time, tick-by-tick valuations of hedge funds assets and an analysis of the risks embedded in the portfolios.

If a hedge fund sells a share of International Business Machines, or if IBM share prices rocket higher, those changes will be instantly reflected in the fund's net asset value. Similarly, PlusFunds will provide an analysis of the risk in a fund that, say, holds a large chunk of Brazilian debt, or has a heavy concentration in airline stocks, or even the likelihood that a dictator will nationalize a country's energy companies. What's more, if investors dislike a fund's risk profile or its investment performance, they can trade the fund's shares on the Bermuda Stock Exchange, six days a week, 22 hours a day.

PlusFunds preserves the confidentiality of hedge-fund managers' trading strategies with the use of "benign transparency." That is, investors can see second-to-second changes in the value of the portfolio, but the actual positions aren't disclosed.

To develop the software to capture the net asset values and the risk exposure, Sugrue worked with Advent Software, a publicly traded company that leads the market in portfolio management software; Ernst & Young, which provides administrative services to hedge funds; and Standard & Poor's, which supplies credit and risk analysis.

Conceivably, PlusFunds could discipline the hedge-fund industry more effectively than an army of auditors from the Securities and Exchange Commission. Each participating fund agrees, in effect, to clone itself as an offshore fund operated by PlusFunds. In turn, PlusFunds feeds information about the clone to Advent for portfolio management, to Ernst & Young for net asset value calculations and to Standard & Poor's for risk analysis.

In contrast, under current arrangements, investment results are much harder to come by. Only the portfolio manager and the brokerage houses that clear the trades know how a fund is performing on a daily basis. Some investors get weekly numbers, but most get results on a monthly or quarterly basis. And of course, even these updates can be misleading, as the SEC's charges against Manhattan Investment Fund last month made clear.

Sugrue claims that PlusFunds' technology would have made it impossible to mislead Manhattan Investment Fund's investors. The SEC charged Manhattan's portfolio manager, Michael Berger, with concocting trades at the end of each month to offset his losses.

"It would have taken too much work to make up trades on a daily basis," points out Sugrue. Similarly, the risks that Long-Term Capital Management was willing to take would have been discovered much earlier under the PlusFunds system.

But because each of the fund's traders were racking up losses in separate accounts, no outside party had a complete picture of the fund positions or the leverage employed to boost returns.

"I think PlusFunds speaks to the issue of risk management and the need to have better control of risk, which is why the regulators have shown their interest," comments Barry Barbash, the former director of the SEC's division of investment management. Barbash, now a securities lawyer in Washington, represents Sugrue.

So far, 43 hedge funds, with a combined $20 billion in assets, have agreed to join PlusFunds. All are offshore funds, open only to foreign investors and tax-exempt U.S. institutions. U.S.-based hedge funds will be eligible to participate, but investors will not be able to trade those funds' shares on the Bermuda Stock Exchange because the shares have not been registered with the SEC.

The Go-Between

"PlusFunds will not remove or even manage the risk in hedge funds. It will just provide insights that were hard to get in the past," observes Ken Tropin, a partner at the $500-million-in-assets Graham Capital Management in Stamford, Connecticut, one of the 43 funds that has signed up for the service.

Sugrue, of course, is not operating this business out of the goodness of his heart. PlusFunds gets paid for acting as a go-between for new investors and the funds. The firm collects a maximum annual fee of 1% of all of the new money that flows into the funds.

Access to the PlusFunds site is free to accredited investors, defined as individuals with a $1 million net worth and institutions with $5 million or more to invest. Some 2,500 investors worldwide have registered with PlusFunds. Those who don't speak English can select one of the site's nine other languages.

Sugrue thinks PlusFunds can transform the hedge-fund world from a $350 billion cottage industry into a $3 trillion global market relatively quickly. Even if PlusFunds falls short of that goal, its technological strides will make hedge funds more accountable, and accountability often serves as the handmaiden to growth.

At the very least, PlusFunds will push hedge funds a step further out of the shadows, giving investors more light with which to judge the product.