Edinburgh Hedge Funds Feel Madoff Effect as Clients Get Pickier

Date: Thursday, September 3, 2009
Author: Rodney Jefferson, Bloomberg

Hedge funds in Edinburgh say they escaped any direct losses from Bernard Madoff’s Ponzi scheme. That doesn’t mean they’re not living with his legacy.

Clients are demanding more disclosure, quicker access to their money and individual, rather than pooled, accounts after Madoff hurt the loosely regulated business, according to managers in the Scottish capital.

“The Madoff thing was a stunner for the market and it did lead to some pretty serious questions being asked by some investors,” said Andrew Kelly, who helps oversee 550 million pounds ($900 million) at Cartesian Capital Partners. “The industry as a whole probably overplayed the secrecy element, saying ‘leave us to run the money, we’re the smart guys here.’”

Hedge funds, which managed $1.43 trillion at the end of June, are competing for clients by disclosing more about their investments as well as trying to ensure returns keep up with global stock prices. The funds should be required to register and disclose data to regulators, the International Organization of Securities Commissions said in June.

The industry’s assets climbed $100 billion in the second quarter as funds advanced by an average 9.1 percent, the biggest gain in more than nine years, Chicago-based Hedge Fund Research Inc. reported on July 21. The MSCI World Index, a measure of developed stock markets, rose 20 percent in the same period.

“What Madoff’s done is throw into sharp relief what happens if you don’t do your proper due diligence,” said Allan MacLeod, managing director of hedge funds at Martin Currie Investment Management Ltd. in Edinburgh. “The bar was being raised anyway, and then Madoff has raised it again.”

Not Geneva

Edinburgh’s financial industry was built on managing money for pension plans and insurance companies. Geneva, whose institutions lost about $7 billion from investments with Madoff, by contrast is centered on private banking for the wealthy. Madoff, 71, is serving a 150-year prison term in Butner, North Carolina, after pleading guilty in a $65 billion fraud.

Martin Currie, the largest manager of hedge funds in the Scottish capital, and city rival SVM Asset Management have been attracting money from institutions. Martin Currie’s hedge fund assets rose about $400 million to $1.2 billion since January as investors become “more diligent and selective,” MacLeod said.

The company hired two people for hedge fund sales this week, one based in London and the other in New York, he said.

SVM received about 20 million pounds from U.K. investors during the past four months for a new regulated retail hedge fund, Chief Executive Officer Colin McLean said.

‘Regulatory Cover’

“Family offices and others, particularly post-Madoff, have really looked to try to protect themselves from being sued and look for that regulatory cover,” said McLean, 56, whose company has about 100 million pounds in so-called long-short strategies, funds that can bet on rising as well as falling markets.

Cartesian is trying to make up the assets it lost last year as clients pulled money, Kelly said. The company has 90 million pounds in hedge funds.

“I am not completely convinced the industry is seeing huge inflows,” said Kelly, 44. “There probably are now net inflows overall, but not significant ones and they are nothing like as significant as the outflows last year. That was devastating.

‘‘We had strong performance last year and had outflows in the order of 20 percent,’’ he said. ‘‘That’s tough.’’

Hedge funds, which are designed to do better when markets fall and tend to lag when they rise, must now show they are worth investing in as stocks rally, according to McLean.

‘More Pressure’

Investments in hedge funds declined 18 percent on average last year, the most since Hedge Fund Research started collecting the data in 1990. The MSCI World Index slumped 42 percent as economies went into recession and the financial industry imploded.

‘‘A lot of people who generally do shorting did quite well last year and all of those have found this year quite difficult,’’ said McLean. ‘‘For funds that fell a bit last year, they are under a bit more pressure to show that they can keep up with markets and do better than conventional equity funds.’’

Those regulated stock funds also aren’t coming under the same scrutiny as the hedge fund industry. While not a hedge fund manager, Madoff’s scheme led to questions about the reviews carried out by firms that manage funds of hedge funds.

These so-called funds of funds were among Madoff’s biggest clients. Madoff demanded anonymity as a cost of doing business, according to PBS’s ‘‘The Madoff Affair” aired on May 12.

Funds of Funds

Funds of funds from Geneva fell 22 percent last year, according to Eurekahedge and Hedge Fund Research. Their assets sank to $15 billion in May from $54.2 billion at the end of 2007, the figures showed.

“There’s no doubt Madoff was a bad thing for hedge funds, particularly for the fund of funds industry,” said MacLeod, 43. “The better quality funds whose due diligence process kept them out of Madoff will prosper.”

That means fund companies have to show more clearly what they are doing with a client’s money, publish more data on holdings and offer cheaper terms for trading stocks, according to the Edinburgh managers.

“If we’re not prepared to tell people what we’re doing, then we have a problem,” said Kelly.

To contact the reporter on this story: Rodney Jefferson in Edinburgh at r.jefferson@bloomberg.net