Hedge Fund Indices for the Purpose of UCITS: Answers to the CESR Issues Paper

This document contains our participation in the consultation process initiated by the CESR on the eligibility of hedge fund indices for the purpose of UCITS (CESR/06-530)

In order to be eligible, hedge fund indices have to be classified as financial indices according to the CESR's definition. The remainder of this document addresses the detailed questions put forward by the CESR (CESR/06-530) and gives EDHEC's views on these issues. In our replies to the detailed questions from the CESR, we argue that hedge fund indices should not be required to offer more controls and more transparency than existing financial indices such as stock market indices. Likewise, their construction should not be subjected to detailed rules for choosing constituents and implementing rebalancing and weighting mechanisms. In fact, there is no reason to discriminate against hedge fund index providers in this sense. Rejecting hedge fund indices seems to be inconsistent with the treatment of indices for other asset classes which face the same types of problems as hedge fund indices. A more promising approach would be to accept hedge fund indices in principle and to require a number of quality criteria, including: - Transparency of the method - A methodology that guarantees a high degree of representativity as well as precise classification of components (such as factor analysis) - Minimum liquidity of the indices - Investability of index components - Prohibition of practices such as backfilling - Information on risk factor exposure This alternative seems to be more convincing than to either reject hedge fund indices on the basis of their shortcomings or to make all hedge fund indices eligible without considering the specific quality of each index. Wide use of high quality hedge fund indices for investment and risk analysis would mark an important step towards proper information for investors on the level of risk in hedge fund products. As a complement to our answers to the questions raised by the CESR, please note our reply to the CESR published earlier (Amenc and Goltz, 2006).

Type: Position paper
Date: le 08/01/2007
Research Cluster : Finance

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