Monday, December 15, 2008

Fund of Funds Party is OVER

Contrary to popular opinion, the best job in America for the past ten years or so has not been that of a hedge fund manger.  Sure, rich people threw money at hedge fund managers, their prime broker let them lever up 50 to 1, and they could charge two-and-twenty on $10 billion in assets under management for barely outperforming T-bills.  No, the best job in America was that of a fund of hedge fund manager.  Why?  Because rich people threw money at fund of funds managers, their prime brokers let them lever up, they could charge two-and-twenty on $10 billion in assets under management for barely outperforming T-bills AND they didn't actually have to do any of the hard work entailed in trying to outperform T-bills.  What fund of funds managers were supposedly paid for was evaluating hedge fund managers and protecting their investors from potential fraud and losses in riskier assets due to a lack of diversification.  Fund of funds were supposed to be mutual funds for rich people.  Except with much higher fees.  This way, if you happened to be a grocery store magnate who had significant assets to invest, but didn't really have the time or patience to follow the market or care to hire your own private investigators to follow your hedge fund manager around, you could rest assured that you were paying someone a truckload of money to do it for you.  The fund of funds industry was founded on this principle.  It was a very clever money-making scheme.  Until Friday.
The most curious part of the Madoff Ponzi scheme pertains not to the rich people handing over their life savings to one guy without asking any questions.  Charming con men have always been able to talk the rich into parting with their cash.  What I find most amazing about this particular fraud is the unearthing of gross negligence in the fund of funds community.  So far, a fund of funds outfit called Fairfield Greenwich has announced the largest loss, that of $7.3 billion from its investment in Madoff's fund.  A $7.3 billion investment would be a perfectly reasonable allocation if Fairfield Greenwich managed around $1 trillion in assets.  But, alas, Fairfield Greenwich only managed $14 billion, having allocated more than half of its assets to one fund - a fund that was notoriously secretive, didn't have a legitimate auditor, or a separate custodian.  So I have to ask:  What exactly did the people at Fairfield Greenwich do all day?  I mean, other than calculate the fees they were earning on the phantom 10% returns that the Madoff fund "generated" for its investors?  After they performed all of that difficult and complicated due diligence that led them to believe that putting $7 billion into one fund was a fabulous investment decision, how did they spend their time at work?  They obviously weren't looking at confirms and making sure that all the returns tied out.  Did they even get statements from the firm?  From what I have read in other reports, the Madoff fund sent out statements that resembled this: "beginning balance $1 million, ending balance $1.2 million," without any further detail.  Weren't the crack investigators at Fairfield interested in a little bit more detail about how their returns were generated?  I am not casually throwing the term "investigator" around either, for one of the founders of Fairfield Greenwich was a former enforcement officer with the SEC, which perhaps explains why the SEC didn't unearth the ponzi scheme before Mr. Madoff's sons turned him in.    
Fairfield was not the only fund that perpetrated such negligence in its asset allocation decisions for clients.  Several other funds are on the list of offenders that had inexplicably large allocations to Madoff, with a few allocating ALL of their assets.  Did the managers of these fund of funds really think that their laziness and complacency was worth the multi-million dollars in fees that they collected?  Certainly their investors don't anymore.  Most of these funds will be sued to high heaven as investors go after refunds of fees collected on profits that never existed.  They won't survive and the founders will be tied up in a mass of litigation for years.  Furthermore, the fund of funds redemption game will begin anew.   

1 comment:

Reggie said...

You missed the real conspiracy here, K10. The Fund-of-Fund concept was devised by lawyers. This is what they've been waiting for to get rich! Er. RichER.