Long-term funeral of the fund-of-funds industry

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Funds of Funds & Madoff: ‘Like Presiding Over the Long-Term Funeral’
Posted by Deal Journal
David Walker, of Financial News, files this dispatch on how funds of funds are discovering the high cost of having done business with Bernard Madoff. Financial News is a Dow Jones publication and a contributor to Deal Journal.

Funds of hedge funds entangled in products managed by Bernard Madoff are slashing fees and writing off investments in a bid to keep investors and cope with the fallout from the alleged fraud by the New York money manager.

Nicola Horlick, manager of fund of funds Bramdean Alternatives, said in a stock exchange filing she has written off Bramdean’s investments in Rye Select Broad Market XL Portfolio and Defender hedge funds, each feeders into Madoff’s investment program. The New Yorker was arrested last month and charged with a fraud which he is alleged to have told authorities could run to $50 billion.

Bramdean had about 9.5% of its assets in the feeder funds and wrote them down as part of its November valuation. This combined with performance from other funds left Bramdean down 9.9% for the month.

Another feeder fund into Madoff, Fairfield Sentry, told its investors this week it wouldn’t charge management or performance fees on any assets they hold in Sentry, according to a document reviewed by Financial News. Sentry had $7.3 billion invested with Bernard Madoff in November, investors said. It is now unclear how much of this was actually there if the investments Madoff claims to have made for them turn out to have been part of a pyramid scheme.

Investors have initiated a class action in New York against Fairfield Greenwich, which managed Sentry, for “breaches of fiduciary duty, negligence and unjust enrichment”, according to court documents. The Connecticut fund manager, which is considering legal action of its own against Madoff, couldn’t be reached for comment.

Another U.S. fund that invested money with Madoff has said it is too early to sue to recover $3.5 billion it put with the 70-year old asset manager. Kingate Management invested the money via two hedge funds. Bloomberg reported the firm wrote to its investors saying “we lose nothing by waiting and we gain the ability to watch as facts unfold.”

A Queen’s Counsel in London said hedge-fund managers caught up in the alleged fraud may be obliged by their fiduciary obligations to investors to pursue legal action to recover assets. “A lot of hedge fund managers will wake up to this because they are all under some form of duty to their investors, and they will have to consider whether that duty requires them to take recovery steps.”

“Watching all this is like presiding over the long-term funeral of the fund-of-funds industry,” said a hedge-fund lawyer in the Cayman Islands. “Madoff has been a huge boost to the litigation and insolvency practice, and it exacerbates the problems the fund of funds industry has had since last year. It will probably lead to a permanent contraction of that industry.”

He said service providers such as auditors of feeder funds into Madoff could be “sued up hill and down dale” this year for not having noticed the fraud, while there could also be “a number of innovative claims against regulators.”