Better Disclosure, Courtesy of Madoff
By Tom Sullivan
INVESTORS IN THE WONDERFUL LAND OF HEDGE FUNDS are starting to pay a lot more attention to what’s happening in the industry’s black boxes, thanks to alleged fraudster Bernard Madoff.
Madoff, as you may have heard, was arrested after losing $40 billion-plus in assets in what apparently was a massive Ponzi scheme. Though he had offered investors little explanation of his methods, he built up his fund with a reputation for consistently solid results and general geniality. He’s got a new rep now.
Hedge-fund managers, who generally resist transparency, are starting to react to a backlash.
Witness Tuckerbrook Alternative Investments, a hedge-fund manager based in Marblehead, Mass. Last week it said it would offer its investors daily asset transparency statements through Citi Hedge Fund Services, an independent third party that’s the largest hedge-fund administrator. Most funds report net asset values monthly.
“It’s from the overhang of the Madoff case,” says John Hassett, managing principal of Tuckerbrook, who promises “the highest level of transparency.”
Tuckerbrook’s investors will receive daily information on returns and the source of any losses or gains. The disclosure also will also show investors that “their money is where it’s supposed to be,” says Hassett. And for all this there are no increases in fees.
Hassett says the funds of hedge funds that invested in Madoff showed themselves to be “emperors without clothes.” Their “additional fees didn’t buy much” in terms of fund selection, he said.
We’re looking at you, Fairfield Greenwich and Tremont. Those two outfits have been hit by shareholder lawsuits for sending money to Madoff.
TO BE FAIR, THE VAST MAJORITY OF FUND of funds, which invest in other hedge funds rather than directly in stocks, bonds and other securities, kept away from Madoff.
Still, the scandal is sure to lead to more transparency for funds of funds, says Jordan Allen, partner with HFR Asset Management, which offers 65 funds of funds with subadvisers.
At the same time, he says, the abysmal performance of hedge funds last year (see below) will prompt some other changes. There probably will be fee reductions and some rethinking of “gates,” he says.
Gating is a fairly common provision that allows hedge- fund managers to limit withdrawals during a redemption period to stop a run on the fund. In the industry, it’s called “raising the gates.”
There are no gates or any redemption restrictions at HFR. There are no lock-ups, either, which are initial commitments by investors that they won’t pull their money for a defined number of years.
HFR’s model may well be the wave of the future, or at least should be.
It prices its funds daily with a third-party administrator, and the funds are subject to regular stress tests. “Clients see the value of their portfolio every day,” he says. The fee is a standard 2% managing fee and 20% of any gains.
ONE WAY TO EASE CONCERNS about hedge-fund investing is to hire a hedge-fund detective.
Enter Ken Springer, the head of Corporate Resolutions and a former special agent for the Federal Bureau of Investigation. His New York-based firm has provided global intelligence gathering and complex fraud investigative services for more than 17 years.
His firm investigates both corporations and investment funds, carrying out character and integrity assessments of management to minimize financial risk. Right now, he says, demand for investigations of funds is picking up noticeably.
Among his services is an ethics hotline, which allows employees and others to report fraud or unethical behavior anonymously to an independent third party.
“If we see a red flag, we ask more questions,” says Springer.
That’s more than the Securities and Exchange Commission ever did with Madoff, apparently.
THE FINAL 2008 NUMBERS are in and, as expected, hedge funds had their worst performance ever. Two years of record growth was wiped out as assets returned to 2006 levels, says Hedge Fund Research.
Investors withdrew a record $155 billion during the year, and hedge-fund assets fell $525 billion from their midyear peak to $1.4 trillion. The HFRI Fund Weighted Composite Index fell by 18.3% for the year.
Welcome, 2009. Maybe.