Party’s Over For Hedge Funds As Madoff Fraud Continues Apace

The Bernard Madoff Ponzi scheme went on claiming scalps throughout yesterday, some troubling, some massively incensing, some instilling a guilty schaudenfraude.

Worst of all of the latest victims is probably Dutch bank Fortis, whose nationalised arm could lose nearly £900m after it lent money to hedge funds who invested in Madoff’s snake oil. Ordinary Dutch folk screwed over by a confidence trickster – go directly to jail Madoff, do not pass Go, do not collect £200.

But as for the hedge funds themselves, some really should have heeded the warnings. As the Ronseal-named hedge fund adviser Jim Hedges says in today’s FT: “This was a train wreck that happened in broad daylight”. He advised against investing with Madoff, as did fellow hedge fund advisors Aksia. But folks looked at Madoff’s consistent monthly return rate and instead of thinking “that’s odd”, just dove straight in. Or, as we shall see, just turned a blind eye and looked at the fat cut they were getting.

Perhaps the real bastards in all of this are the feeder funds, who acted as middlemen and channelled funds from regular folk into Madoff’s funds. Madoff didn’t charge them any fees, to make his investment vehicle more attractive; he got his money from the brokerage fees made off trading stocks in the accounts. The feeder funds on the other hand charged huge fees – Fairfield Greenwich took 20% of profits and a 1% management fee, Tremont took a well-over-the-odds 1.25% management fee. Both didn’t have conditions set for them, “such as ones requiring that minimum returns be reached before fees would be paid”, according to the FT.

So the news that Fairfield lost over $7.5bn and that Tremont’s Rye Investment had $3.1bn (virtually the whole fund) invested in Madoff Securities makes the blood boil. Some fund managers made a Faustian pact to pump other people’s money into a dodgy fund because their returns were so good and uncomplicated. Pass the flaming pitchfork. 

So what of individuals with stakes in these various funds? If you’re able to invest in a hedge fund, you’ve probably been dealt a pretty good hand in life, and probably aren’t going to default on your house/find it hard to feed your children even if you got stung. So when I read Bloomberg’s email correspondence with panicking folks with money invested with Madoff, part of me wants to gloat over the Icarus-like fall of the wealthy, but it’s pretty hard to read the stuff about grandmothers with their life savings signed up to these charlatans.

Some are suggesting that the scandal could be what finally destroys confidence in hedge funds altogether, those betting shops dressed up in Armani rather than Reebok. Hedge fund advisory body IGS said yesterday that it expects a third of all hedge funds to fail after investors, spooked by the diminishing returns and general financial malaise are pulling money out. After the number of funds reached over 10,000 in June, the highest ever level, they’re waning hard. Despite the first half of the year bringing these record levels, fund levels have fallen 18% year-on-year since last November. That’s a lot of money gone in the last couple of months.

What with low interest rates as well, I think I’m just going to hand over my finances to fate and chuck my savings into Premium Bonds. It’s like the lottery for unadventurous people!

Posted by Ben Beaumont-Thomas in Hot Money | December 16, 2008 12:57PM |