Hedge Funds, Ponzi's and Madoff

In recent times the hedge fund industry has received negative press, whether its problems with access to funds or a

In recent times the hedge fund industry has received negative press, whether its problems with access to funds or a Maddof style ponzi scheme. Investors have had to learn to adapt to today’s climate, and in effect have leant toward asset management, achieving transparency and, in many cases, superior liquidity. Previously hedge funds were for Ultra High Net worth Individuals or institutional investors, providing (in theory) secure absolute return. The concept conjured images of dynamic financial professionals at the top of their game offering a low risk, high yielding investment package for a select group of investors. Today the imagery is much bleaker. Visions of Bernie Madoff, the former chairman of Bernard L. Madoff Investment Securities, being harassed by photographers and journalists alike, having faced 11 federal charges including securities fraud and money laundering at the federal courthouse in Lower Manhatten, New York.

 

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So how did Madoff get away with it for so long?

 

Hedge funds are exempt from regulation for the most part and lack transparency. So many hedge funds offer different investment models, making due diligence extremely difficult to execute; the arena can rapidly become a mine field. This lack of transparency enabled Madoff to execute the largest investor fraud ever committed by a single person. When Madoff’s fraudulent activity was exposed, Federal prosecutors estimated client losses, which included fabricated gains, of almost $65 billion. The U.S. Securities and Exchange Commission (SEC) had previously conducted several investigations into Madoff’s business practices since 1999, which critics contend were incompetently handled.

 

This fraudulent activity has left millions of investors sceptical of the financial industry, particularly hedge funds, and has paved the way for a new criteria of investment. With the focus on transparency and liquidity.

 

Managed accounts offer a more complete solution to match the current climates investment requirements. Transparency of trading and client funds is crucial for many investors, and will remain so for the future. Having the advantage of logging into your own personal account in real time, accessing trading reports and seeing how the asset manager is performing offers superior transparency to a quarterly P&L report, which has been the typical practise of hedge funds.

 

Risk appetite differs from one investor to the next. It is paramount that when selecting your managed account you have a complete understanding of the risks involved. Is there a max draw-down preventing a margin call? How much leverage is being applied to the trading? Managed accounts offer another distinct advantage; whilst hedge funds have been reserved for the financially elite, managed accounts can offer a much more cost effective route to market.

 

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The entry levels for managed accounts vary and can occasionally be tailored to suit the client. As with any investment it is essential that any funds deposited is capital that you can afford to lose.

 

Regulators around the globe have quite literally had to step up their game to protect the investor. Month on month we have seen forex brokers terminate their businesses or relocate to countries offering less stringent financial regulation for various reasons including lack of capital as well as more sinister reasons. As investors open segregated accounts with the broker partner, it is vital that due dlilgence is carried out an all aspects of the investment opportunity. Is the broker regulated? If so, by who? How does the regulatory body protect the client? In the event of the broker liquidating their assets, what happens to your investment?

These questions should be answered prior to progressing with the relationship.

 

US regulatory body, the National Futures Association, have taken several steps to weed out rogue brokers by increasing the capital requirements for regulation. It makes sense that a broker with healthy collateral offers superior security than one who cannot match the monetary requirements for regulation, although there is always an exception to the rule. Here in Switzerland, FINMA demands forex brokers now require a bank license to continue their practise. This has caused many brokers to relocate or to close. Asset managers worth their salt will deal with regulated brokers of high a caliber enabling their investors transparency and a secure environment in which their funds will be traded.

 

Liquidity of your investment can be determined by several factors. Investing in a hedge fund may require you to keep your capital locked up for a number of years. With your capital being pooled with other investor’s capital, redemptions must be submitted in accordance with the funds memorandum; typically months in advance as capital can quite literally be locked in positions dependent on strategy.

 

Separately managed accounts are managed by limited power of attorney or LPOA. In simpler terms, the asset manager trades your brokerage account. The LPOA will not be on a trade only basis, the firm will not have power to withdraw funds from, nor deposit funds to the client account. Investors will not be able to trade their accounts at the same time as this wopuld likely conflict with the traders strategy and could lead to catastrophic results. Whilst managed accounts are usually traded in liquid environments you should discuss redemptions with your asset manager. Typically freedom to withdraw profits or capital from your account is the investors choice.

 

Hedge fund managers frequently made headlines for their incentive driven performance related pay. Most hedge funds incorporate a “2 and 20” approach. This being 2% management fee on entry and 20% of the profits, this can vary from one fund to another. The contract between the fund and client will detail the conditions of the relationship, including risk management, asset classes

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