Adding Yield to Stable Portfolios: Regulating Investments in Australian Hedge Funds

Abstract:     
This article explains the nature of hedge funds and, in particular, the main investment strategies followed by hedge funds. It also provides an overview of the Australian hedge fund sector.

The article, in contrast to the majority of the legal commentary on hedge funds, examines hedge funds from the "buy-side" perspective - it considers whether hedge funds are appropriate investments, under Australian law, for fund managers, superannuation trustees and other fiduciaries.

Under Australian law, fiduciaries must act prudently when investing the funds entrusted to them. On a strict formulation of this duty of prudence, with its insistence on capital preservation, it is almost certain that fiduciaries would be barred from investing in hedge funds. However, it is likely that the Australian courts will follow the lead of the English and United States courts in recasting the prudent investor rule in terms of modern portfolio theory, thus bringing hedge funds within the universe of (potentially) permissible investments for fiduciaries.

Moreover, where a fiduciary invests in a "fund of hedge funds", as opposed to directly investing in a hedge fund, a further issue arises - whether the fiduciary has breached its duty to act personally, since, in a fund of hedge funds, the fiduciary plays no part in the selection and monitoring of the underlying hedge funds. This article examines the Australian law on the delegation of investment powers by fiduciaries and considers the statutory modifications to the common law strictures on delegation.

Number of Pages in PDF File: 33

Keywords: Hedge Funds, Alternative Investments, Prudent Investor Rule

JEL Classification: G23, K22

working papers series