fund governance trends: 2018 industry data & recommended … · 2019-04-02 · fund governance...

Fund Governance Trends:2018 Industry Data &

Recommended Best Practices

Best Practices SeriesFebruary 2019

EXECUTIVE SUMMARY1. For the past eight years, SFA has collected data on more than 2,100 Cayman hedge fund boards. This

data has consistently shown a trend toward stronger governance. While gains were more incremental last year, the improvements continue.

a) External directors served on almost 90% of funds and were a majority on 77% of fund boards.b) The industry is coalescing around two board configurations. The most prevalent configuration

has two external directors and one internal director. Almost half of funds have that profile now. The second common profile is having no internal directors with two to three externals. The “no internals” configuration now accounts for almost one-quarter of our fund universe.

c) The percentage of funds opting for “split” boards – meaning the external directors work for different firms – is settling in at more than 60%. We have bested that mark for funds launched in 2015-2017. We expect funds launched in 2018 to hit that mark next year.

2. This year we take a look at gender representation on fund boards. About 30% of all hedge funds with external directors have a female external director, about on par with US mutual funds. But almost all those funds only have one woman, so the total number of external board seats held by women is 15%. Furthermore, the allocation of female directorships is more concentrated. The top 10 women account for 42% of all external seats held by women. The corresponding number for men is only 18%. (Page 6.)

3. This year we suggest some questions managers and investors might ask current or prospective board members as part of their due diligence. These questions should help shed light on how well a board is operating or how well you might expect it to operate. (Page 7.)

4. We have included our views on best practices in fund governance for board composition, responsibilities, meetings and shareholder interaction. (Starting on page 8.)

February 8, 2019 www.soundfundadvisors.com

February 8, 2019

Fund Governance TrendsSound Fund Advisors

Chart Summary

24%

55%

15%

4%2%

# of Internal Directors

Zero One Two Three Four +

9%

68%

18%

5%

# of External Directors

One Two Three Four +

69%74% 74%

80%

89%89% 88%89%

50%55%60%65%70%75%80%85%90%95%

11 12 13 14 15 16 17 18

50%

55%

50%

59% 61% 63%

54%

20%25%30%35%40%45%50%55%60%65%

< 13 13 14 15 16 17 18

www.soundfundadvisors.com 2

43%47%

49%54%

66%73% 74%77%

30%

40%

50%

60%

70%

80%

90%

100%

11 12 13 14 15 16 17 18

% of All Funds w/ Ext. Majority % Split Boards by Fund Vintage

% of Funds w/ External Director

72% 72%81%81% 80%

85% 87%90%

30%

40%

50%

60%

70%

80%

90%

100%

11 12 13 14 15 16 17 18

% of UK Funds w/ Ext. Majority

% of Boards with Female External(1)% of Funds with Female External

No F70%

1 F27%

2 F3%

Gender of External Board Seats

Male85%

Female15% 29%

32%

39%

0%5%

10%15%20%25%30%35%40%45%

Hedge Funds

Mutual Funds

Big Mutual Funds

(1) SFA and BoardIQ Special Issue, “Baby Steps Towards Fund Director Diversity: Diversity at Fund Boards and the Complexes they Oversee,” April 24, 2018

In 2018, governance trends continued to consolidatethe important qualitative gains made in recent years.The percentage of funds with external directorscontinues to hover around 90% and now more thanthree-quarters of all funds have a majority of externaldirectors on their fund boards. The most commonconfiguration remains two external directors and oneinternal director. But almost as prevalent is thenumber of funds where there are only externaldirectors. While we see the benefit in havingrepresentation of the investment manager on theboard, certainly this trend enhances the independenceof external board members. For those funds withmultiple external directors, “split boards,” where thedirectors work at different firms remain the norm.This suggests that managers and investors see value insplit boards since directorship firms typically structuretheir fees to incentivize funds not to split their boards.

This year we looked at two new issues: (i) genderrepresentation on fund boards, and (ii) what kinds ofquestions managers and investors can ask fund boardsto assess their quality/functioning. In the case of theformer, we put out a report last summer that was ourfirst examination of gender diversity on hedge fundboards. Overall, the representation of women onhedge fund boards lags what we see in corporateboards and is more akin to mutual fund boards, withone exception. The concentration of female hedgefund directors is quite a bit higher than male directors.More on this on page 6.

Our second theme this year stems from thequestioning we get by investors and managers as partof their due diligence process. Some investors andmanagers struggle to know what to ask to accuratelyassess the health and vibrancy of a board. On page 7we get into some of the better questions we have beenasked and why these are are related to the quality offund boards.

SEC Director DataIn our description of the current state of governance,we will be relying on calendar-year 2018 data madeavailable by the US Securities and ExchangeCommission (“SEC”). Some offshore funds file aForm D or D/A (an amended Form D) with the SEC-- typically to allow them to issue securities exemptfrom SEC registration to tax-exempt US investors,such as foundations, endowments or public retirement

plans. Data from the Form D, therefore, does notcapture the entire fund universe. One simple estimateof the completeness of the data set is that there were7,654 funds registered in Cayman Islands as ofDecember 31, 2018 (excluding Master Funds), whileour Form D dataset shows 2,137 Cayman funds filinga Form D. Therefore, we are capturing approximately28% of all Cayman funds. We should also note thatour data may be over-estimating the quality of fundgovernance practices. The universe of funds that file aForm D with the SEC is large but is not a randomselection of all funds. Funds that can successfullymarket to US tax-exempt investors are more likely topay attention to important issues like governance. Amore complete description is available in Appendix I.

Board Composition DistributionBased on our data, we were able to identify individualsas either internal or external directors. To put it briefly,an internal director either works for the investmentmanager/advisor or for an organization with anownership interest in the investment manager/advisor.An external director is anybody on a fund board thatdoesn’t fit the criteria for an internal director. Thedistribution of board seats looks like the following:

February 8, 2019


Number of Internal Directors

Num

ber o

f Ext

erna

l Dire

ctor

s 0 1 2 3+ Sum

0 2% 6% 3% 11%

1 1% 3% 3% 1% 8%

2 11% 45% 3% 2% 61%

3+ 12% 5% 3% 0% 20%

Sum 24% 55% 15% 6%


for most funds.

Do External Directors Have Control?A very evident trend has been the move toward amajority of external directors. Currently, more thanthree-quarters of funds have an external majority. Thisis consistent with practices in Europe andCommonwealth countries which have a much longerhistory of majority-external boards. UK-managedfunds, for example, have external majorities in almost90% of cases.

The Preferred ModelThe data for 2018 confirm the continued dominance ofa particular fund board profile, namely, funds with two

The representation of external directors on fundboards has started to plateau at around 90%.

How Many Internal Directors?Having a single internal director is the most commonconfiguration, though there are still a range ofconfigurations. Boards without any internals has beenmore common with European and Commonwealth-based managers, but increasingly that model ismigrating to US managers. Almost one-quarter offunds now have that configuration. Multiple internalsare rare outside of larger asset management firms.

How Many External Directors?The majority of funds have two external directors.With the appropriate director profiles, this is sufficient

February 8, 2019


# of External Directors

Two 70%

One 10%

Three 16%

4+ 4%

69%74% 74%

80%

89% 89% 88% 89%

40%

50%

60%

70%

80%

90%

100%

11 12 13 14 15 16 17 18

% of Funds w/ External Director

43%47%

49%54%

66%

73% 74%77%

30%35%40%45%50%55%60%65%70%75%80%

11 12 13 14 15 16 17 18

% of Funds w/ External Majority


# of Internal Directors

One 55%

Zero 22%Two 16%

3+ 7%

external directors and one internal director. While thishas always been a popular profile, currently almost halfof existing funds have moved to this configuration.There are a number of possible reasons why this modelis increasingly accepted as the new norm. First, the twoexternal, one internal configuration situates the boardto tackle conflict of interest issues that may ariseregarding the manager and the fund. Second, a threemember board is likely to have several of theimportant competencies or experience sets essential forgood governance (e.g. audit, investments, legal,operations, etc.) While larger funds would benefit fromthe added diversification of more board members,three members seems like a minimum. Third, withthree members, the board can be relatively efficient.Whether it is a realistic concern or not, some managersworry about the board being a procedural impedimentto timely decision-making. These concerns are relativelytrivial with three board members. Finally, having twoexternal members is appropriately mindful of the costsof governance. If investors want quality boardmembers (as they should), then funds will need to payappropriate compensation. Having two externalsstrikes a good balance between cost and benefit,especially in a fund’s earlier years.

External Directors and Split BoardsThe quality of the fund board is entirely related to thequality of its people. The best credentials and structureare meaningless with the wrong people. But there arestructural factors that can help improve governance.

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One increasingly accepted method is to have externaldirectors coming from different firms (“split boards”).While it is sometimes described as more “efficient” tohave two external directors from the same firm, itcompromises the effectiveness of the second directorfor several reasons: (i) as a consequence of the historyand culture of the organization providing the directors,the two directors are likely to have similar backgrounds,(ii) frequently the two directors will informally assignone of them to be a “lead director” and the otherdirector may pay less attention and rely on the lead forinformation and guidance, and (iii) directors from thesame firm may be more likely to defer to each other.Effectively this reduces the two external directors tosomething akin to one external director. This practice iscommon in less-developed governance situationsbecause the external directorship firm will frequentlydiscount the price for the second director. This makesit appealing to start-up funds or firms that are lookingfor easy, turn-key answers. But the data suggest thatmanagers and investors are recognizing the value ofsplit boards. The chart below shows the percentage ofsplit boards (where there are two external directors) bythe year in which the fund was formed.

While there appears to be a small drop-off in splitboards for 2018, this may be related to a structuralreporting lag. We note that split boards for 2017vintage funds were first reported as 56% and now arerunning at 63%. We will keep an eye on this“seasonal.”


50%55%

50%

59% 61% 63%

54%

20%25%30%35%40%45%50%55%60%65%70%

Pre-13 2013 2014 2015 2016 2017 2018

% of Split Boards by Vintage

23%26%

28% 29%

38%

46% 45% 45%

10%15%20%25%30%35%40%45%50%

11 12 13 14 15 16 17 18

% Funds: 2 External, 1 Internal


Gender Representation on Fund BoardsOver the years, this white paper has looked at anumber of characteristics of fund diversity. Last year’spaper, for example, looked at two factors: the areas ofdirector expertise (legal, audit, administration, e.g.) thatwere most commonly represented on boards and themove towards increased representation of US-basedfund directors. In previous years, we analyzed diversityas it relates to size and type of the director’s firm,director capacity, and the background of the internaldirector. We continue to report annually on thenumber of split boards to emphasize the importance ofdiversity as it relates to which firms directors work for.In 2018, we begin reporting on gender diversity inhedge fund boards. We are excited to do this becausewe are not aware that this data is available anywhereelse. We also believe that it is a relevant factor andconsideration for putting together fund boards, just asthe other factors that we have historically reported onare also relevant. Managers and investors would bebest served to consider all of them when assessing thequality of a fund’s board.

Our examination of gender diversity on boards wasprimarily focused on external directors. There were1,892 funds that had external directors and where wewere able to get information on the external directors’gender. On those 1,892 funds, there were 4,146external board seats (i.e., on average, there are 2.19externals per fund.) Of those 4,146 seats, 614 or 15%of them, were filled by women. This overstates thescarcity of women on boards because, on average, thereare two external seats per board. 30% of funds had atleast one female external director. But very few funds(under 3%) had two women on their boards, and nofunds had more than two female external directors.The cause of the under-representation of “multiplefemale” boards may warrant further investigation.

Also remarkable was the level of “concentration”amongst female directors. If we look at the top 10women with the most board seats, their collective tallyaccounts for 42% of all seats held by women. Thecorresponding number for the top 10 men accounts foronly 18% of all seats held by a man. To put itdifferently, you could invite 13 women to a conferenceand have in one small room the majority of all female-held hedge fund board seats. To accomplish the samefeat, you would have to invite 50 men.

February 8, 2019



Male85%

Female15%

Gender of External Board Seats

No F70%

One F27%

2+ F3%

% Boards with Female Externals

29%32%

39%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Hedge Funds

Mutual Funds

Big Mutual Funds

% Boards with Female Externals (1)

(1) SFA and BoardIQ Special Issue, “Baby Steps Towards Fund Director Diversity: Diversity at Fund Boards and the Complexes they Oversee,” April 24, 2018

Questions to Ask Your External DirectorsEven after the 2008-2009 financial crisis highlightedissues of governance, due diligence on directorsremains at a relatively early stage of development.Many managers and investors are rightly sensitive toissues of director capacity and finding a good mix ofdirector background/experience. We hope thatcontinues. In this section, we thought it could behelpful to provide some more atypical questions thatmight assist managers and investors in their assessmentof the workings of the board. All are questions we havebeen previously asked and which we found to beparticularly insightful and meaningful in reviewing therole of the director and the quality of the board. Thatsaid, we would be delighted to receive any furthersuggestions!

• Frequency: How often does the board meet?Physically and telephonically? How many times ayear are all directors present in the same location?

• Attendance: Has an alternate director ever beenrequired? Why? Which service providers havepresented at the meetings during the course of theyear? Has the board ever spoken to a valuationagent?

• Communication: How often do the directorsspeak to each other outside of board meetings?Using the director’s largest client as an example,when was the last time the director physically metwith a member of the Investment Manager onsitebut outside of a board meeting to discuss a fundmatter? For what purpose?

• Decision-making: Describe a situation where theboard started without a consensus (amongstmembers or with the Manager) and how the boardwas able to reach agreement. Have the directorsever resigned a directorship other than for thenormal closure of a fund?

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• Process: Does the Board review ValuationCommittee minutes? Brokerage Committeeminutes? Trade allocation exceptions? Tradeerrors? Side letters? Account allocation exceptions?Does the board approve (or receive regularnotification) of the opening of bank or collateralaccounts?

• Tracking: If the manager has other investmentvehicles or funds, is the performance of thosevehicles compared to the Fund to identify trackingerror? How is this presented to the board?

• Investors: How often does the board memberattend or participate in investor events?

• Valuation: What is the board’s role with regard tothe fund’s valuation? Have the directors reviewedsupporting material for valuations that are done byappraisal firms such as Duff & Phelps or HoulihanLokey? Does the Board approve of managermarks?

• Side Letters: What does the director think are themost important issues funds should consider withregard to side letters?

• Conflicts: Are the directors affiliated with anyentities that have business relationships with thefund or the manager (e.g. law firms, anti-moneylaundering oversight)? Do the directors receive anycompensation for any other services from theinvestment managers? Are the directors invested inthe Fund?

The SFA View on Best Practices in Fund Governance

Let’s start with the obvious: almost all hedge funds arestarted at the instigation of a particular investmentmanager as a vehicle to effectuate a particularinvestment strategy or approach. This differsimportantly from a traditional corporate model wheredirectors are actively involved in setting a strategicdirection or vision and hiring management to executeon it. Investors in corporations that suffer poormanagement may reasonably expect the board toappoint new managers. But investors in hedge fundsmake the hiring/firing decisions themselves by stickingwith or redeeming from their investments.

But this increased investor responsibility does not meanthat directors cannot add significant value. Investorsshould be protected from conflicts of interest, frommisrepresentations of investment strategies or risks,and from misconduct or fraud. Investment managersbenefit from having knowledgeable professionalsinvolved with their funds who can guide processeswhere conflicts may exist and be available to investorsthat have concerns.

Best Practices: An Absolute or Relative Concept?Discussions of best practices often start with a fixedconcept – the ideal, so to speak. But perhaps a morerealistic view of best practices is to acknowledge thatpractices should evolve depending on the resources,size and complexity of a fund or fund complex. Theprimary problem with regard to hedge fund governanceisn’t a lack of awareness of how boards should beconstituted or how boards should practice. Theproblem is the apparent stickiness or inertia of boardsand practices that made sense when funds were $50million but no longer make sense when they are ten ortwenty times that size. In other areas, we expect fundsto evolve as their assets, strategies and operationalcomplexity grow. The same should be true with ourapproach to governance. So, best practices may not bea fixed point but a continuum, and funds judged asmuch by their movement as by fixed standards. Ineach section of our discussion, we will talk about ideals,but we will also include a paragraph on what smallerfunds may accomplish with more limited resources.

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I. Board composition

The most important contributor to strong fundgovernance is an excellent board. The best governanceprocedures will be ineffectual in the hands of a group ofdisinterested or conflicted individuals. We believe thatbest practices in board composition involves thefollowing:

① A board composed of representatives of theinvestment manager in addition to independentdirectors. Independent directors should be independentof both the investment manager and each other. Thismeans that the directors, their firms or affiliates are notreceiving fees from the investment manager for anyother services. In addition, it is also our view thatdirectors should not be either shareholders or LPs.While having a director who is also a shareholder mayheighten their attention, it also creates situations wherehis/her personal interests may conflict with the interestsof the broader group of shareholders.

② The investment managers’ representatives on theboard should include the CIO or the COO orcomparable person in charge of non-investmentactivities. The perspective of the investment managershould be represented on the board. Additionally,including the CIO and COO on the board creates apersonal legal responsibility for the fund’s propermanagement.

③ The independent directors should have a majority ofthe votes on the board – or their approval should berequired for certain actions such as suspendingredemptions or changing the liquidity terms of the fund.

④ In order to provide meaningful oversight, the board– and especially its independent directors - should havea diversity of experience. The areas of functionalinsight should include: legal, regulatory,markets/investment strategies, operational, audit, fundadministration and risk management.

⑤While professional independent directors will workfor a number of funds, the capacity of a director shouldallow that director to devote significant time andattention even during periods of high market stress, likeQ4 2008. There is not an exact science to the number



of funds or relationships a director can handle, but thedirector should be transparent about the number ofassignments they have both to investors and theinvestment manager.

⑥Director compensation should be reasonable forthe amount of work involved in the assignment andmay differ from director to director based on their levelof experience and expertise.

⑦ Directors should be willing and able to travel tomeet the investment manager and participate in face-to-face board meetings at least twice per year. There is nosubstitute for spending time and being with themanager and other board members.

Smaller Funds: Smaller funds are likely to start with aboard primarily or entirely comprised of internaldirectors. There should be at least two internaldirectors covering investment and operational areasand the boards should be operating in a transparent,structured manner. Even with limited budgets, a third-party firm can be engaged to provide corporatesecretarial services (compiling and distributing agendasand meeting materials, taking minutes, establishingfollow-up schedules. etc.). This can be an importantprod to keeping the trains running on time. As andwhen practical, firms would add their first independentdirector.

II. The role of the board

While the board will typically delegate many day-to-dayresponsibilities to third parties like the investmentmanager, administrator, auditors, etc., the board retainsvery important roles and responsibilities. These wouldinclude the following:

① Monitoring Strategy, Risk and Liquidity Profile. TheInvestment Management Agreement will specificallydelegate the responsibilities for selecting investments,portfolio construction, risk management andtrading/dealing to the investment manager. The boardshould be ensuring, however, that when the investmentmanager is exercising these responsibilities that he orshe is doing so in a manner that is consistent with theprospectus and other materials that have been providedto investors.

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Put simply, the board ensures that the manager adheresto investment, risk and liquidity restrictions.Independent directors should take the lead in this rolebecause of the inherent conflict of interest for “inside”directors. While this can often seem relativelystraightforward, many funds adapt and change withmarket conditions over time. The independentdirectors are charged with the responsibility to ensurethat this change does not constitute wholesale strategydrift or a change in risk or investment profile thatdiffers materially from what was described toinvestors. The directors may be helped in this regard byrequesting that the administrator prepare reports for theboard that would highlight changes in security types orstrategy profile.

② Monitoring Service Providers. The investment managerwill be responsible for daily interaction with third-partyservice providers such as prime brokers, auditors andlegal counsel, but the board should supervise andapprove the selection of these providers and interactwith them at regular intervals. This providesshareholders with an important protection against either(i) conflicts of interest between the service providersand the investment manager, and (ii) fraud ormisconduct – which typically would require somecombination of misconduct and negligence by theinvestment manager and the fund’s other serviceproviders.

③ Valuation. One of the most important risks ingovernance today is the uncomfortable level ofvagueness of exactly who is ultimately responsible forvaluation of the fund’s assets. It is clear that thedirectors perform a role in the valuation process, butthat role may differ from fund to fund. What isimportant is that all roles be clearly defined andacknowledged, whether it be the directors, theinvestment manager, the administrator, the valuationagent or any other third party and that this becommunicated properly to investors. With regard tothe directors specifically, the board should do thefollowing: (i) review Valuation Committee minutes on amonthly or quarterly basis, (ii) annually approvevaluation procedures and processes, (iii) approve anyexceptions to the agreed-upon procedures, (iv) be awareof valuations on hard-to-value or exotic securities, (v)sign off on any transactions that are done between



vehicles that are advised by the investment manager,and (vi) receive and review NAV packages on amonthly or quarterly basis.

④ Audit. The directors are directly responsible forapproving the annual audit for the fund. In practice,this means the directors hire and supervise the auditfirm, engage the auditor in active dialogue tounderstand the financial compliance environment, andsatisfy themselves that the accounts are accurate.

⑤Accuracy of Fund Information. The directors areresponsible for the accuracy, completeness andtimeliness of official communications by the fund toinvestors and potential investors. This includes theoffering memorandum, constitutional documents,subscription documents, and periodic valuations.This information should be reviewed on an annualbasis to make sure that it remains accurate. In caseswhere the board is relying on third parties such as theadministrator or investment manager to send thisinformation, it should receive positive assurance thatthis has been done on a timely basis. Of course, thedirectors should also be aware of and conversant withcommunication directly between the investmentmanager and shareholders or potential shareholders(monthly or quarterly updates, risk information,marketing materials, etc.).

⑥ Side Letters. The board should be actively involvedin the granting of any special terms and conditionsthat are codified in a “side letter”.

⑦ Discretionary Powers. The board ultimately exercisesthe discretionary powers granted to it by theprospectus. This includes more mundane items likethe ability to waive sales fees, minimum investmentamounts, redemption fees or subscription cut-offtimes/dates. But it also includes the very substantialdiscretion to impose or waive gates, suspendredemptions and the calculation of the NAV. Thesediscretionary powers are often fraught with potentialconflicts for directors who also work for theinvestment manager. Therefore, it is important thatindependent directors play a substantial role in theapplication of most discretionary powers.

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⑧ Shareholder Communication. The board should bewell acquainted with efforts undertaken to market thefunds as well as shareholder relations. This wouldinclude understanding the target client base, the currentmix and needs of shareholders, redemption andsubscription requests or schedules, the capacity of theinvestment strategies, shareholder correspondence andshareholder events. Individual directors should beavailable to meet or listen to shareholders who haveconcerns or issues with the funds. These effortsgenerally will enhance shareholder retention.

Smaller Funds: It is especially important for smallerfunds without independent directors that the internaldirectors provide ample documentation of theiractivities as directors, distinct from their correspondingrole as members of the investment manager. Forexample, the exercise of discretionary powers or over-riding of valuation procedures should be done in thecontext of board meetings and not during the normalcourse of duty as the investment manager.

III. Director Interaction/Board Meetings

In order to fulfill the responsibilities discussed above,the director will need to spend a material amount oftime upfront familiarizing him or herself with theinvestment manager and other service providers. Ineffect, the director should be engaging in a due diligenceprocess that would be akin to that conducted by athorough professional investor. As one simple test, adirector should know as much about a fund and itsmanager as its investors. Subsequent to this assessment,directors will typically interact with other boardmembers and the investment manager through aschedule of board meetings. We recommend thefollowing:

① The schedule of board meetings should bedetermined in advance and should be conducted with afrequency no less than 3 times per year. In many cases,board meetings should take place quarterly. In addition,the Board will meet (typically telephonically) to reviewthe final audit results with the auditor at the end of Q1.At least two meetings a year should occur with all boardmembers physically present.



② The agenda for board meetings should be providedin advance and materials supporting items to bediscussed should be provided with sufficient time fordirectors to properly consider them.

③ Third party servicer providers such asadministrators and auditors should be invited toparticipate during part of these meetings to report outon their areas of relevance.

④While formal meetings are important, boardmembers should be ready and prepared to meetformally or informally at any time as issues or marketconditions dictate.

The agenda for Board meetings may vary from meetingto meeting depending on time of year and the issues athand. But a typical agenda should include thefollowing:

Ø Review of investment performance, risk andliquidity profile.

Ø Review of upcoming subscriptions and redemptions.

Ø Discussion of marketing efforts and shareholdersissues or communication.

Ø Review of staffing or infrastructure changes at theinvestment manager.

Ø Review of new account openings/counterpartiesand counterparty exposure.

Ø Discussion of legal, regulatory or compliance issuesor communication.

Ø Presentation by Valuation Committee of results,exceptions, procedures.

Ø Presentation by Administrator of NAV package,ASC 820 leveling, asset verification.

Ø Presentation by Administrator of AMLprocedures/issues, non-standard subscriptions orredemptions. Annually, the Board should meet withthe Fund’s AML officers to discuss their findings.

Ø Presentation by Auditor of annual accounts andapproval as required (annually).

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Ø Review of side letters.

Ø Review of any requests for discretionarypowers/waivers.

Ø ERISA issues.

Ø Review appointment of service providers andengagement of auditor (annually)

Ø Approve renewal of D&O insurance (annually).

Smaller Funds: Smaller fund boards should meet atleast twice per year, and it would be good for at leastone of those meetings to be with all directors physicallypresent. While the agenda for a board meeting withonly internal directors may be abridged, it shoulddemonstrate that all important roles have beendiscussed and minuted.

IV. Shareholder interaction

We believe that directors should be sensitive to theneeds and interests of shareholders. This means thatdirectors should provide transparency on the work theyhave done for the fund, the specifics of their interactionwith other directors and how decisions were made, andissues that were considered. But this transparencyneeds to be coordinated with the investment managerand directors should be careful to provide equivalentlevels of information to all investors. While minutes ofboard meetings are typically not provided, detailedboard agendas should be available to all shareholders.

During normal times, directors should participate inshareholder events. During periods of market or fundstress, directors should be available to shareholders tounderstand their concerns and issues. Ultimately thiscommunication will help the fund (and the investmentmanager) by making sure that investor concerns areheard.

What about Master Fund LP Governance?Increasingly, master funds have been organized aslimited partnerships. This creates asymmetry ingovernance and a lack of oversight of funds even ifthere are external directors at the offshore feeder level.In a more normal environment, the external directorswould have transparency into the master fund in orderto fulfill their responsibilities at the feeder level. Butsome investors are sensitive to the fact that directors



wouldn’t be directly involved if the fund exerciseddiscretionary authority to suspend redemptions orother extraordinary measures. To alleviate theseconcerns, some master funds have created advisory orgovernance committees whose approval is required forthe GP to take certain actions. The actions wouldtypically be outlined in the limited partnershipagreement and the advisory committees would typicallyhave the same members as a fund’s offshore board ofdirectors. We expect the presence of advisorycommittees to become more common as best practicesin fund governance evolve.

Best Practices Checklistü A board with 3-5 individuals, a voting majority of which are independent, external directors.

ü External board directors that have diverse skill sets and include markets and strategy knowledge, legal/regulatory experience, risk and operations.

ü External board directors with the appropriatenumber of assignments and focus to providesignificant time, attention and oversight even duringperiods of market stress.

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About Sound Fund AdvisorsSound Fund Advisors ("SFA") was founded in 2011 to provide focused and active directorship services to asset management firms and institutional hedge funds. The firm's approach brings market, risk and due diligence experience to firms that are interested in best practices in fund governance.

SFA was founded by Jonathan Morgan who has served as a hedge fund strategist, portfolio manager, principal and investor for more than 18 years. From 2002 until 2011, he has was the head of hedge fund research and manager selection at Julius Baer Alternatives (2002-2005), Barclays Global Investors (2005-2009) and UBP Asset Management (2009-2011). Prior to that, Mr. Morgan was a markets strategist at three different hedge funds. He graduated from Princeton University in 1986 and Harvard’s John F. Kennedy School in 1990.

Ramona Bowry is a director of SFA. Prior to joining SFA she was Senior Vice President and Head of Operational Due Diligence at MaplesFS. Prior to joining MaplesFS in 2012, she was a founding partner, director and company secretary of A.R.C. Directors Ltd., a Cayman domiciled professional services firm specialising in the provision of non-executive directors to the alternative investment industry. Prior to that, Ramona was based in London where she was Director of Business Development at DPM Europe Ltd., an independent offshore hedge fund administrator which is now part of Bank of New York Mellon. Ramona began her career as a risk analyst for Bright Capital, a hedge fund manager and trading adviser. Ramona is a FCA Securities & Financial Derivatives representative. She holds a Bachelor of Science in Economics and History from University College London.


ü Board meetings at least three or four times per year, of which two are face-to-face with all board members present.

ü External board directors who spend significant time upfront becoming familiar with the fund and its operations.

ü A board that is actively involved in monitoring the fund’s valuation process.

ü A board that interacts regularly with the fund’s service providers and asks them to participate in board meetings.

ü A board that interacts with shareholders and is transparent and available to them, especially during periods of stress.

üA board that is cognizant of the particular compliance and regulatory requirements of the fund.

ü An advisory board at the master level if the master is organized as a limited partnership that would approve certain actions as outlined in the limited partnership agreement.


Appendix I – SEC Data TreatmentThis analysis is based on information included in FormD and Form D/As filed with the SEC duringcalendar-year 2018 for hedge funds domiciled in theCayman Islands. Funds that self-designated as“Master Funds” in their name have been excluded tomitigate the possibility of double-counting unless itcould be verified that this was not the case. Limitedpartnerships were also excluded. In total, there were2,137 unique funds that met these criteria. There are2,142 people associated with these funds who serve asdirectors. A person is an Internal director if they self-designate as an “Executive” of the fund on their FormD, or if we associated them with the fund throughpublically available information. A person is alsoconsidered to be an Internal director if they work foreither the investment advisor/manager of the fund, orthey work for an entity which controls or has an equitystake in the investment manager. In cases where afund is on a hedge fund platform, employees of theplatform provider are considered Internals. Externaldirectors have no direct ties to the fund and this termis interchangeable with independent director or non-executive director. In cases where directors serve asindependent directors for the investment manageritself and for the underlying fund, the director isconsidered an external director despite the potentialfor some conflict. The universe of External directorsis derived from publically available information,including information provided by service providersthemselves. In order to be conservative in ouranalysis, we have assumed that directors that cannototherwise be identified are External directors. Thenumber in each category are as follows:

Internal Directors: 1,447 personsExternal Directors: 695 persons

Manager Location and SizeIn addition to the data collected from SEC records, wehave associated each fund with an investment advisor.The location of the investment advisor was obtainedfrom publically available sources.

February 8, 2019



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