Hedge Funds Get Operational Risk Rated, But Why?

By Cory Levine, Wall Street & Technology

Research and ratings authority Moody's Investors Services has released the first of what it expects to be many ratings on the complex and opaque world of hedge funds. The ratings will be based on what Moody's has dubbed Operational Quality (OQ), which addresses the internal and external aspects of the fund including valuation process, service providers, accounting controls, regulatory compliance, risk reporting and control, legal and financial structure, human resources, and other operational issues specific to the individual fund.The first fund to subject itself to Moody's scrutiny is New York-based Sorin Capital Management, LLC. The firm voluntarily opened itself up to Moody's analysts who conducted and on-site review of the fund's operational policies and procedures. The OQ ratings will be by request only, opening up questions to the effectiveness of the review, and the value of the ratings to investors.

Although gaining the type of access necessary to effectively evaluate a fund's operational risk would be near impossible without their voluntary consent, the value of ratings derived from voluntary exposure is highly suspect. It is hard to believe that a fund that might receive a low rating would volunteer to be examined by Moody's, and those that do have likely conducted an extensive internal review before exposing themselves publicly.

Further, I wonder if the parameters of Moody's reviews are truly sufficient to rate the operational risk of a fund company. What is your opinion? Is it possible for Moody's ratings system to be an effective indicator of operational risk? Leave your thoughts in the Comments section.