Rogue hedge funds will lie, cheat and connive to get investor money, and while the regulators lack muscle to stop them, there are ways for pension funds to quickly spot the next Madoff.

Professor Stephen Brown, a top academic who presented at a hearing on financial services before the US Congress in 2007, said his latest research on hedge fund due diligence found that the sector has turned lying to investors into a fine art.

“We find that incomplete and inaccurate disclosure is common in this sub-segment of the market,” he said.

Worse, hedge fund managers are fully aware that their statements will be verified and they still lie anyway.

“It’s almost as if there’s an optimal degree of lying. That if you don’t lie enough, maybe your investors will go to someone else. If you lie too much, then your investor will be pissed and go away, too.”

Not that all hedge funds are chronically truth-challenged. On the contrary, Brown stressed the importance of investing in the right hedge fund because a separate research shows the good ones do deliver diversification benefits and higher returns than long-only funds.

“We can all agree that pension funds should invest in common equities, but if you look at the facts, common equities are, in general, more risky than hedge funds as a whole,” he said.

To avoid hedge funds that are likely to implode, Brown said pension funds should take operational due diligence reports seriously. These reports can cost around US$12,000 – lunch money compared to the size of investment mandates.

These due diligence reports can easily identify the ‘problem funds’ or those that are likely to fail.

Epic fail

“Problem funds tend to have longer lock-up and redemption periods, less likely to use external pricing and less likely to have a big four auditor,” said Brown.

“Other leading indicators are that they misrepresent facts most of the time; there are problems verifying statements that they make; they keep switching the auditor and they don’t have an independent administrator.”

Brown said that his study revealed the non-problem funds, or those that score well based on the due diligence reports, have consistently performed better than problem funds.

In other words, and it may sound obvious, but ‘honest’ hedge funds do well in the long run, he said.

Brown’s frustration is that many pension funds often ask for the due diligence report after they’ve handed the cheque. Worse, even when the report comes back with bad news, the pension fund don’t take their money out.

He said pension funds must do it the other way around and get the due diligence report first and then sign the cheque, particularly ahead of imminent US regulation.

“What the . If they don’t, they don’t have the defense that nobody told them.”

As for the role of the regulator on stopping another Madoff-style collapse, Brown said that the Securities and Exchange Commission (SEC) is ill-equipped to police and punish all hedge funds – some 20,000 of them in the US alone.

“Investors who rely on the SEC to do the due diligence on their behalf are like people who rely on the kindness of strangers. It’s not a good idea.”

Brown, David S. Loeb professor in finance at New York University Stern School of Business, was speaking at a roundtable organised by the Investment Management Consultants Association (IMCA) Australia early this week.

Lois Peltz – President,  Infovest21

2008 was a notorious year for hedge funds with negative absolute performance, liquidity problems, style drift and manager fraud. As a result, investors are demanding more control, transparency, liquidity, due diligence and in some cases, customization. They want a safer way to invest with hedge funds. (more)

Many Investors are a little unsure how the high water mark works on their Managed Account, today we write a little how we apply this fee to your account within our managed account platform
At the end of each calender month a fee of (for example) 20% will be applied to new net trading profits using a high water mark.  A high water mark is established each time a new performance fee is applied.  This means no additional performance fee may be applied until the high profit watermark has been surpassed.
Example -  The first month your $100,000 account experiences gains of $10,000 in profit, $2,000 (20% of $10,000) is our performance fee giving your account net profit of $8,000 and a total balance of $108,000.  If next month your account looses $3,000 then no performance fee will be taken giving you a total balance of $105,000.  The third month your account makes $8,000 in profit now giving you a balance of $113,000.  Your fee this month with be $1,000 (20% of $5,000).  Your account balance will now be $112,000 and a new high watermark has been set.

by Carol E. Curtis
Managed account platforms, which represent 2 percent to 4 percent of hedge fund industry assets, are growing rapidly and could account for as much as 20 percent of total industry assets by 2014, according to a report released Monday by Infovest 21, a New York City-based information services provider to the alternative investment industry.
Managed account platforms consist of segregated assets under an infrastructure that provides a high level of risk management, transparency, liquidity and due diligence, often for a fee. “They can be a lower risk way to invest in hedge funds,” said Lois Peltz, president of Infovest 21, in an interview.
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Value At Risk (VaR), is the method used by finance professionals to measure risk levels within their portfolios. There is much material available on the web for investors to research VaR in depth if they wish, however for the purpose of this article we will apply a definition of VaR as it relates to our methodology for risk management using automated systems trading in our client Managed Accounts business.
Value At Risk (VaR), is the nominated maximum risk of loss to an investors capital within a particular trading system over a specified 12 month period of investment.

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Today Saverio Berlinzani launched a trial of our new “live Manual Trading ” room to attendees from Italy and Australia.  The feedback was absolutely positive with Saverio’s passion for trading and deep knowledge of how Forex markets work on show for everyone. Watch this space for the start date of the live “Trading Room”, daily Monday to Friday.