Hedge fund industry still feeling Madoff effect

Date: Friday, March 27, 2009
Author: Reuters.com

Bernard Madoff is behind bars, but the effects of his fraud are still reverberating in the hedge fund industry, with more redemptions expected and investor confidence decimated.

Traumatized investors are now more likely to closely monitor where their money is and who is managing it, hedge fund professionals said at the Reuters Private Equity and Hedge Funds Summit this week.

"You know, it is just absolutely devastating," said Anthony Scaramucci, managing partner at SkyBridge Capital, referring to the Madoff scandal.

"You talk about the markets, the markets are about confidence. You talk about money management, money management is ultimately about trust," he said.

SkyBridge, which provides seed capital for managers launching funds, saw redemptions tick up in the days following Madoff's arrest in December. The veteran financier has pleaded guilty to a massive Ponzi scheme in which investors lost as much as $65 billion.

Even though hedge fund professionals say they were not spooked by the Madoff debacle, investors were, and money managers are already seeing a change in investor behavior.

"The effect it is having in the hedge fund industry is that people are looking for more third-party validation of pricing and positions," said Alex Ehrlich, head of global prime services at Swiss bank UBS (UBSN.VX: Quote, Profile, Research, Stock Buzz)(UBS.N: Quote, Profile, Research, Stock Buzz).

Investors are also less likely to accept having their money dumped into funds without knowing where it is and who exactly is managing it, Ehrlich said.

Some in the industry say they are working with regulators to put in place measures that will soothe investors.

"We are working with some of the administrators right now and some of the accounting firms to look at what can be done to address the issues of verification of securities ownership, for example," said Paul Roth, founding partner of law firm Schulte Roth & Zabel LLP. He said many of the firm's clients lost money in the Madoff affair.

Madoff-inspired fund redemptions will likely be more apparent next week -- even among funds that did not invest in Madoff instruments -- because the scandal broke after December 1, one fund manager said.

Investors typically have to give 30 to 60 days' notice before the end of a quarter to take their money out of a fund, meaning the earliest date many investors can make Madoff-inspired redemptions is March 31.

"None of the high-quality funds of funds invested in Madoff," said Carrie McCabe, chief executive of Lasair Capital and an industry veteran. Still, she said, European investors in particular were spooked and led redemptions.

The Madoff scandal has contributed to redemptions that could shrink the hedge fund industry by half, to $1 trillion, by the end of the year, she said.

The problem now is that burned investors may be guided by irrational fear, the managers said.

"Greed overcomes wisdom," Scaramucci said, quoting his Italian grandfather to explain the froth endemic at the end of an economic cycle.

"Now you just have to be careful that the fear does not overcome wisdom."

(Editing by John Wallace)