Hedge Funds and Private Equity Need Full Disclosure
Many function just like mutual funds or ETFs, yet operate behind a veil of secrecy.
Bloomberg, November 19, 2019

Today’s column is about more complete disclosure for hedge funds, private equity and venture capital funds.

It traces to our recent interview with University of Chicago Booth School of Business economics professor Eugene Fama. I asked him this question:

“What sort of opportunity for outperformance do you see in private markets given that information in that space is so much more opaque?”

The father of the efficient markets hypothesis & 2013 Nobel Laureate explained:

“The problem is there are lots of good people studying that, but they’re hamstrung by the lack of good data on funds who live and die . . . It’s self-reported, it’s not like mutual funds. You get a very biased set of data on that.”

I wish we had more time to explore the issue further. But Fama’s answer led me to think about this more deeply about this.  Why aren’t VCs and private equity and hedge funds required to fully report data like traditional mutual funds are? They must register with the SEC if they are large enough, but they do not have to disclose audited performance returns, reveal how much in assets they manage, or what their top holdings are, or which auditor they use. They don’t even have to reveal who their senior management is.

This has been on my mind in part because of the surge of interest in these higher risk alternatives among foundations and college endowments, and partly because of a steady drum beat of fraud, Ponzi schemes, and other bad behavior in the space.

Beyond reducing fraud, there are numerous other benefits versus a modest list of drawbacks of what I call “Reg Alt D,” or the full disclosure of key information from funds in the alternative space.

Positives:

-Providing greater information allows otherwise opaque, complicated investment strategies to be more readily understandable by all investors.
-PE/VC firms are already creating audited returns for their LPs; new rules should simply mandate disclosure to SEC and the public;
-More information allows better informed decisions by allocators;
-Transparency benefits all market participants;
-Academics will produce useful research on the value of private markets and the best practices for selecting a manager.

Negatives:

-Sophisticated investors don’t (shouldn’t) require government oversight; they can and do access information to make such investment determinations;
-More regulation could make this space even more expensive;
-Expensive investments already justify their costs to investors;
-Greater oversight is a paternalistic overreach by the nanny-state;
-Efficient markets (eventually) incorporate data like return information into prices.

See the full column here.

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I originally published this at Bloomberg, November 19, 2019. All of my Bloomberg columns can be found here and here.