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Ratings agencies scope out hedge funds

With interest in hedge funds exploding, some ratings agencies are starting to scrutinize the lightly regulated, opaque industry.

Moody's Investors Service in New York is one. It's developing a methodology for rating hedge fund operations and plans to release its first rating by the end of April. The ratings are focused on U.S. funds but may well include some Canadian funds farther down the road.

The move comes as global interest has soared in Canada's $30-billion hedge fund industry, lured by its exposure to commodities prices. However, the industry has been plagued recently by several high-profile scandals, such as the collapse of Portus Alternative Asset Management Inc. and Norshield Financial Group.

Gary Witt, a managing director at Moody's, hopes the ratings will help investors and ensure that all hedge funds aren't tarred with the same brush.

"We think this makes a lot of sense to have this done in a centralized place from a credible company whose business it is to do these types of things," he said in an interview. He's hired three people to work exclusively in this area.

Mr. Witt stressed that the hedge fund ratings aren't credit ratings but rather an assessment of the quality of the fund's operations. There will be five categories, ranging from "excellent" to "poor." Part of the research will include criminal background checks on the principals of the fund, and seeing whether there are any past securities' violations.

"Mainly we're going to be focusing on what their own marketing materials say," he said. "Who are they saying are the important people and what are they saying about those people? We're going to check that it's all true."

Because hedge funds aren't subject to the same types of disclosure rules as other investments, Moody's will rate only those funds that are forthcoming with information.

Moody's isn't alone. Chicago-based Morningstar Inc. said it plans to start releasing research reports on hedge funds this year.

Standard & Poor's Corp. already rates a few hedge funds and said it's expanding its coverage of the industry.

Not everyone's interested, though. Dominion Bond Rating Service Ltd., based in Toronto, said it currently has no plans to rate hedge funds.

The industry itself is trying to clean up its image. Last summer, the Investment Funds Institute of Canada and Canadian Hedge Watch launched an accreditation program for hedge fund managers, the first of its kind.

"With the growing demand for hedge funds globally (expected to quadruple in the next decade) and the lack of education in the area among financial planners . . . financial analysts and investors in Canada, there was a real need for this program," Tony Sanfelice, president of Canadian Hedge Watch, said in an e-mail.

© 2007 The Globe and Mail. All rights reserved.

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