One third of the world’s biggest fund management groups are running leveraged funds alongside their more conventional portfolios, raising the possibility of conflicts of interest within asset management groups.


ClientKnowledge, a UK-based research consultancy, interviewed 177 of the world’s biggest fund management groups, with an average of $122bn each under management. One third of those surveyed ran leveraged funds, which often trade on margin, taking positions without owning all of the underlying assets, to gear up the returns they produce.

According to ClientKnowledge research, obtained exclusively by the FT, half the investment groups surveyed that ran leveraged funds had the same managers responsible for both leveraged and conventional portfolios. In 75 per cent of those cases, the same trading desk executed the trades.

"This raises some interesting questions about precisely how well-defined the divisions between the different types of money are, and the dealing etiquette this engenders," said Justyn Trenner, chief executive of ClientKnowledge and one of the report’s authors.

"If a fund group’s proprietary leverage fund has to execute a market-moving deal at a similar time to a traditional pension fund doing the same deal, how would the concurrent orders be managed and prioritised?" he asked.

Critics have suggested that leveraged funds, which have fewer restrictions on their operations than more traditional funds, could profit from "front running" - using their knowledge to conduct trades ahead of other funds in the group for extra profits.

"Front-running is clearly a concern," said Jedd Wilder, a partner at Orrick Herrington & Sutcliffe, a New York law firm.

Another problem could arise, he said, if a conventional fund held a long position in a particular asset while a hedge fund run by the same group was selling the underlying asset short.

"It could end up having a negative impact on either the returns of the hedge fund or the mutual fund," he added. However, he said a lot of asset managers were looking at ways of resolving the potential conflicts.

The report comes at a difficult time for fund management groups, already under scrutiny from regulators in the UK and the US for trading and marketing practices.

Leveraged funds have grown in popularity as money managers, including pension funds, seek to diversify their portfolios. Hedge funds, traditionally only for the very wealthy, have become more accessible to mainstream investors.

In almost half the cases where ClientKnowledge found money managers ran both types of funds, the leveraged fund was connected to very large traditional funds with assets between $100bn and $1,000bn.

"This would tend to underscore the point that it appears to be the bigger funds, including pension funds, which are most interested in diversifying into the higher-risk leveraged fund sector," said Mr Trenner.

(FT.com)