NETHERLANDS – The Dutch financial regulator AFM says hedge funds’ lack of transparency is a cause for concern – and that investors don’t have enough understanding of the funds’ investment policies and risk profiles.

It also said pension fund activity in the asset class may have an impact on market volatility.

“The AFM considers the lack of transparency of hedge funds to be a cause for concern,” the Autoriteit Financiële Markten said in a release. It’s a “key area of regulatory concern”.

It has compiled a 74-page report called “Hedge Funds: An exploratory study of conduct-related issues”.

The AFM argued that pension funds’ considerable allocation to hedge funds “indirectly exposes a much broader section of the public to this investment category”.

“Consequently, the potential risks associated with these products are becoming relevant to a growing and more vulnerable part of the investor population.”

The AFM noted that pension funds were investing in hedge funds in an effort to diversify and boost returns. “What seems clear is that hedge funds will increasingly depend on institutional investors for their capital. Some market watchers believe that in few years time pension funds could account for as much as half of all hedge fund inflows.”

And it noted the increasing exposure of Dutch pension funds to the asset class. MN Services has around €850m while Stichting Pensioenfonds ABP has almost €3.8bn invested, it said.

And there may be a knock-on effect. “For example, the way in which pension funds implement their risk management may also add to volatility and lead to major price fluctuations.

“These institutions work primarily with risk budgets and may be forced to liquidate positions in shares if they are in danger of exceeding the boundaries of their budget. If they are at the bottom of their budget, they sell their shares. That happens when share prices are falling. Conversely they will buy more when prices are rising.”

The AFM said it “calls into question whether fund managers themselves always have sufficient understanding of the investment policies and the risk profile of the hedge funds in which they invest”.

“This might put at risk investors' interests.”

Despite all this, the AFM says it sees “no pressing need” for more regulation or tighter supervision. But a follow-up investigation is to be carried out at a number of institutions – “in order to obtain more information about Dutch market practices”.

It said only five single manager and around 45 fund-of-hedge funds are registered on the Dutch market.

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