•  
• Tweet
•  
•  
•        Print
•  
•        Email
•  
•         Track Keywords

The news broke in Europe on Friday, 12 December, when Bernard Madoff was arrested by the FBI and charged with securities fraud. Many of the leading Swiss fund of funds were hit as the financial crisis has moved from redemptions and liquidity to one of confidence in attracting investors. The big names are reported to have lost billions, but the damage does not stop there due to the effect of asset managers’ placements with private banks who had also been lured by apparent rock-steady returns.

According to the testimony and submission to the SEC (Securities and Exchange Commission) by Harry Markopolos, as far back as 2002 some two dozen Swiss and French private banks and fund of funds were clamouring to place money with the man. This link has meant that most individual asset managers - and there are literally hundreds in Geneva alone - have had some exposure to the scheme.

It is difficult to calculate the scale of the problem. Totals for Swiss exposure are rumored to be $10bn and most of the big names are affected, though some of these companies have protected or indemnified investors from a portion of the losses. On the other hand, investors have also started to take legal steps with court action for insufficient diversification of risk and lack of sufficient controls.

Why? The list of red flags inherent with Bernie Madoff’s feeder funds should have set the alarm bells ringing. The fact that they did not may say more about human nature and the herd instinct than the science of due diligence. His smooth returns and closure to new investors left those inside with a steady return at a perceived minimal risk given the years during which he had been operating the fraud.

What next? The fundamentals in terms of performance for hedge fund investments are set to improve after the disaster of 2008; year-to-date returns see a much more positive position. The financial services industry is normally first into and first out of any recession, though we have not seen anything like the intensity of the current recession for a very long time.

Our view is that the industry will scale down costs to match the lower revenues and assets under management, reducing staff or closing offices where needed. The survivors will come out stronger, and we expect the returns possible through the best fund investments will coax investors back. Many of these, including pension funds and family offices, lost more on traditional investments than in their hedge fund investments last year. Expect them to include an alternative element in their portfolio, but to be much more demanding on knowing how their money is being invested and the operational controls in place. Since opening the Geneva office 16 months ago, we at Kinetic expect to see more demand for outsourced specialist services such as investment due diligence as well as process and procedure reviews to help firms re-size and adapt to new structures.

Access to Kinetic's April 2009 newsletter:
http://www.kinetic-partners.com/public/page.asp?n=12&sr=newsletter
glen.millar@kinetic-partners.com