Hedge fund blowup or ponzi scheme?

[godoftrading]

How many hedge funds blew up in the last 12 months? How many of these supposed blow-ups were to really disguise carefully crafted ponzi schemes? How easy would it be to tell investors that you simply made some bad bets rather then telling them that you stole their money?

If you are someone like Neiderhoffer, then I guess its better to be thought of as a fool then a crook.

 

[Bowball]

its important to note that a hedge fund is only different to a regular fund in one significant respect - flexibility (awarded through lower regulation). there are plenty of high risk hedge funds out there, but there are also plenty of low risk ones too. just have a look at how many funds (hedge or otherwise) have gone tits and that should give you an idea.

as an addition, even 2 years ago when times were good, something like 30% of hedge funds folded within a year. notbecause of fraud or anything sinister, but because they didnt make their clients enough/any money, or they couldnt raise funds, or because they got unlucky with the number of reemptions

 

[Bowball]

i also know about half a dozen succesful hedge fund managers. i would hazard a guess that the proportion of Ponzi schemes ranges from about 1 to infinitessimaly-small-number

 

[BSD]

Well said GJ !

Forbes had an excellent piece about hedge funds back in 2001, and fundamentally nothing much has changed since:

The $500 Billion Hedge Fund Folly

(A mere 500 Bill was the size of the industry back then)

Some excerpts:

"The $500 Billion Hedge Fund Folly

James M. Clash, Robert Lenzner and Michael Maiello with Josephine Lee, 08.06.01

What's so alluring about unregulated investment partnerships? They soak you with high fees and underperform the market.

What do Barbra Streisand, Senator Robert Torricelli and Bianca Jagger have in common? They have all lost money investing in hedge funds.

You don't have a hedge fund to brag about at lawn parties? That could be because you're too timid to swing for the fences, as these private investment partnerships often do with leverage and exotic derivatives. It could be because you are not well connected. Hedge funds, after all, cannot advertise, so you have to know someone to get in one. Maybe you are not rich enough. These funds for the elite are allowed to take only "sophisticated" investors, defined as people with a $200,000 annual income or a $1 million investable net worth.

Or maybe you are not in a hedge fund because you know better.

...The usual hedge fund contract at least protects you from getting whipsawed by a manager who makes money one year, loses it the next and makes it back the third year. The "high-water mark" provision works this way: If the manager gets an incentive fee for taking the fund up X%, he doesn't get additional incentive fees until the fund tops a cumulative X% return. Say the manager doubles a $10 million pot to $20 million, pocketing a $2 million incentive. The next year the $18 million pot shrinks to $10 million. Additional incentive fees are due only to the extent the manager pushes the fund above $20 million.

Sadly for investors, the high-water mark carry has created a flight syndrome among hedge operators. If they have a really bad year they just fold up shop. After suffering heavy losses in 1999 Julian Robertson simply closed up what was left of his $22 billion (peak) Tiger Management hedge fund. It would take years for him to climb out of the hole. Of course if he ever wanted to start fresh with a new management company, there would be no high-water mark.

If you want to know what's wrong with the hedge fund concept, spend some time with John Bogle, founder of the Vanguard Group. He has spent his 50-year career agitating for lower investment costs and so is naturally hostile to things like one-sided incentive fees. But he makes a compelling argument. When you are contemplating the returns you can get from investing this way, he says, don't think about the 456% that this or that manager made in a good year, think about the collective returns from the whole style.

"I think it's inconceivable that you could take $500 billion run by 6,000 different managers and expect these managers to be smarter than the rest of the world," says Bogle. If the overall market is up 10%, he calculates, then hedge fund operators would need a 17% return to beat that--given a 20% carry, a 2% annual fee and taxes. "I don't think that $500 billion has a remote chance of beating 17%," he says.

((Let alone the hundreds of Billions being run today))

...Here's the beauty of hedge funds for operators, if not investors: Anybody can open one. "Every Tom, Dick and Harry is putting out a shingle," laments Elizabeth Hilpman, a partner in Barlow Partners, a seven-year-old New York hedge fund of funds. "It's become harder to tell the good managers from the bad."

No kidding. Paul Mozer, whose fast-and-loose bond trading landed him a prison term and almost tanked Salomon Brothers, is said to have started a hedge fund. And John Meriwether, a figure of widespread ignominy after Long-Term Capital imploded, has simply launched a new hedge fund, JWM Partners.

Look at some of the charlatans who have invaded the field. The secretive nature of hedge funds makes them enticing vehicles for con artists (see p. 72). For instance, after the SEC suspended him in 1993 ex-Goldman Sachs mortgage trader Michael Smirlock raised $700 million to start three hedge funds. Last December he again fell afoul of the SEC, which sued him for hiding $70 million in losses from his investors.

The obituary list of hedge funds should give pause to anyone imagining that all these contraptions are bound for glory. Bad bets blew a hole in Streisand's fund, BKP Partners, in mid-1998. She was party to a class suit against manager Robert K. Pryt and his onetime $270 million fund, finally striking a settlement for 1% to 2% of investors' initial outlays. Torricelli, the ever-controversial New Jersey Democrat, and his ex-girlfriend Bianca Jagger (Mick's ex-wife) were in the $13 million Porpoise Fund when it went south, also in 1998. Rick Yune, the hot young movie actor (The Fast and the Furious), used to be a Wall Street trader; still, he lost money in three hedge funds and now is out of them entirely.

The unhappy truth is most hedge funds can't deliver on their promise of beating the broader stock market over the long haul. During the last five years (through May 2001), the S&P 500 returned an annual 15%. But 9 of the 10 weight-averaged classes of hedge funds monitored by CSFB Tremont delivered sub-S&P returns, after fees. Over ten years hedge funds look even worse. According to MarHedge, another hedge fund tracker, of its 14 major hedge fund categories only 1, called Global Established Markets, beat the S&P's 18% return from 1990 through the middle of last year, and it did so by a rounding margin.

Even worse news: These system-wide figures are too kind to hedge funds. Their managers have no obligation to report returns to the SEC. This business has no Morningstar or Lipper; hedge fund trackers cover just a portion of the business. If hedge fund operators don't feel like answering a survey during a bad quarter, they don't. In 2000's first quarter 1,068 hedge funds reported to MarHedge, by year-end 160 of them, or 15%, were missing in action. Commodities speculator Victor Niederhoffer reported assets of $125 million to MarHedge in July 1997. In October of that year his position on the Thai baht wiped out his fund. Rather than record a 100% drop in the fund's assets, Niederhoffer simply disappeared from MarHedge's list.

Auditors are no help, either. Unlike those examining corporations and mutual funds, where they work for investors, hedge fund auditors are in the employ of the managers. Whatever independence accounting firms can muster in their corporate work, it stands to reason they have still less with the hedgies. Ernst & Young and Deloitte & Touche both did audit work for scamster Berger. It wasn't their fault, they said; Berger deceived them.

Still, you're thinking, aren't there geniuses out there who could make money for me? Didn't Warren Buffett have a hedge fund back in the 1960s, before he bought control of Berkshire Hathaway? I just have to find the next Warren Buffett.

Good luck. You and several hundred thousand other investors are looking for a few geniuses camouflaged in a crowd of racetrack touts. "

 

[Skill Leverage]

However it doesn't have to be a Ponzi scheme to be morally (and indeed legally) questionable. Read 'when genius failed' (I tell this to everyone I know, including trainees on the desk etc) to see how the mechanics of an outwardly legitimate (if fundamentally flawed) hedge fund can be twisted into something undesirable surprisingly easily.

Just read a synopsis, sounds like an interesting read. I think there are some good funds out there, but the ones I like are far more than just a bunch of heavily backed traders; they will seek out specific companies to invest in, take an active interest in their management vs balance sheet, and try to help that company maximise profitability, thus driving up their share price. I would imagine this to be a far more effective strategy on the scale that hedge funds operate than simply placing large orders in the markets.

That said, I have to confess I don't know a great deal about the industry; just my $0.02. Which incidentally are costing me a lot more than my two cents did a year ago...

 

[BSD]

Such an involved hands-on approach is more to the tune of what private equity firms like KKR do.

KKR: Kohlberg Kravis Roberts & Co

Overview of the field:

Private equity - Wikipedia, the free encyclopedia

Babarians at the gate is a good read for anybody interested:

Amazon.com: Barbarians at the Gate: The Fall of RJR Nabisco: Bryan Burrough, John Helyar: Books

About the at the time largest leveraged buyout to date.

 

[gooseman]

there's a report that was handed to the SEC back in 2000 which contained so many warnings and "red flags" about why Madoff was a PONZI and it was brushed aside. One of the "flags" was that a large Arab money fund wanted to invest and hired one of the big 4 accountancies to do their due diligence and Madoff said no, thye could only use his accountants as they didn't want to reveal his trading "strategy". So they invested $200m anyway......

 

[Skill Leverage]

Such an involved hands-on approach is more to the tune of what private equity firms like KKR do.

KKR: Kohlberg Kravis Roberts & Co

Overview of the field:

Private equity - Wikipedia, the free encyclopedia

Babarians at the gate is a good read for anybody interested:

Amazon.com: Barbarians at the Gate: The Fall of RJR Nabisco: Bryan Burrough, John Helyar: Books

About the at the time largest leveraged buyout to date.

Ah - I was under the impression that PE was more about raising money for mergers and such things. But as I said, I don't know a great deal about that side of things yet, I am but a Padawan.

 

[dilesh23]

there's a report that was handed to the SEC back in 2000 which contained so many warnings and "red flags" about why Madoff was a PONZI and it was brushed aside. One of the "flags" was that a large Arab money fund wanted to invest and hired one of the big 4 accountancies to do their due diligence and Madoff said no, thye could only use his accountants as they didn't want to reveal his trading "strategy". So they invested $200m anyway......

Madoff must be singing this song all the way to his jail cell (and doing the dance in the shower)

YouTube - Busta Rhymes (Feat. Ron Browz) - Arab Money

 

[oildaytrader]

How many hedge funds blew up in the last 12 months? How many of these supposed blow-ups were to really disguise carefully crafted ponzi schemes? How easy would it be to tell investors that you simply made some bad bets rather then telling them that you stole their money?

If you are someone like Neiderhoffer, then I guess its better to be thought of as a fool then a crook.

1500 crooks ran off with money