Madoff exposure went beyond the ultra-rich

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Madoff exposure went beyond the ultra-rich
Tue Jan 20, 2009 6:29pm
By Martin de Sa'Pinto

ZURICH (Reuters) - While wealthy investors are the principal victims of Bernard Madoff's alleged $50 billion fraud, less affluent investors were also hit via products with lower minimum-investment thresholds, asset managers said.

By the time of the Madoff collapse some products were available giving indirect access where the minimum investment was far lower than that required to invest directly in Madoff or its feeder funds.

"As things progressed Madoff lowered his own minimums and entry criteria in the hunt for cash. This brought more institutions in, resulting in broader distribution," said one Zurich-based private banker who asked not to be named.

It was a far cry from the early days, when access to Madoff funds was restricted to institutions investing tens or hundreds of millions of dollars, or to the super-rich such as clothing entrepreneur Carl Shapiro, who invested $500 million.

"At the start Bernard L. Madoff Investment Securities was a sort of an exclusive club, very difficult to get into," said one former hedge fund manager and Monaco-based private investor who said he had been offered Madoff funds but had not invested.

"The reported returns were great and volatility was low, and so naturally many of the world's richest investors wanted access. The fact that not everyone could get in made Madoff funds even more enticing," he said.

Later on, a number of Madoff feeders took investments of as little as $50,000. One was Dublin-listed, Ucits III-compliant Thema International Fund plc and could also be distributed in Switzerland. It managed $1.25 billion as of November 2008.

The Luxembourg-registered Luxalpha Sicav American Selection Fund, which managed an estimated $1.4 billion, was another. UBS has said it established the fund in response to client requests.

Structured products, securities that mirror the performance of an underlying asset such as a fund or index, also came into play. These products can be distributed broadly, and usually charge high fees and commissions.

The private banker from Zurich said his bank's clients lost $5 million investing in a leveraged structured product issued by Nomura Bank in 2006 and offered via private placements.

In private placements, investment products are sold to a restricted number of investors, generally institutions, which can then distribute them to a broader base of clients.

The Nomura product charged clients interest on leverage of 120 basis points over one-month U.S. dollar LIBOR. The issue amount was $50 million, and while clients lost all their money, Nomura lost the $100 million which it had supplied in leverage.

Spain's BBVA said in a statement on its website it faces losses of up to 300 million euros ($389.3 million) related to products structured for and distributed by third parties.

French bank BNP Paribas, which said it could lose $350 million as a result of lending against Madoff-related collateral, offered a structured product for third party distribution in Germany. A spokesperson on Tuesday said losses on this product were "less than 1.0 million euros."

Although tough regulation limits hedge fund distribution in Germany, the nation is one of the largest markets for structured products, many built on hedge funds. No data is yet available on Germany's losses on Madoff via structured products.

Certain investors may have unwitting exposure to Madoff, as the owners of structured products built on fund of funds where Madoff was one of the portfolio funds.

For example the $3.8 billion Reichmuth Matterhorn fund, offered by Swiss private bank Reichmuth, was a top performing fund of funds for years, an ideal building block for a structured product. Matterhorn had 8.6 percent of its assets in Madoff.

A structured product from Hauck & Aufaeuser, another private bank, gave investors full exposure to Matterhorn with a minimum investment of 50,000 euros, half the fund's own minimum.

Assets invested in this product peaked at 143 million euros in June, falling back to 80 million euros by November as the credit crisis caused forced liquidations and the Lehman collapse alerted investors to the realities of counterparty risk.

"We recommended an allocation of a maximum five percent to this product. In the context of a diversified portfolio, it is a nuisance but not a disaster," Felix Hoepsner, head of communications at Reichmuth, told Reuters.

Hoepsner said that with the recommended allocation, client losses to Madoff would be less than one percent of assets.

Given the broad diffusion of Madoff-related products in fund of funds, investor losses in structured products built on such funds are likely to mount, analysts say.

(Editing by Elaine Hardcastle)