Three items crossed my desk last week that reminded me that we are not in a post-madoff world, we are in a post-trust world.
1. The first point was the headline grabbing news that Galleon founder Raj Rajaratnam was indicted for insider trading. One can only imagine how the blossoming networks of hedge funds, analysts and corporate insiders will recoil back into their shells after this alarming news. How does an investor control against this risk? Very difficult. Whereas “Information Edge” was once an advantage, no, a given, now we can expect investors to ask a few more questions on how managers will specifically describe their information advantage.
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2. The blockbuster news followed a relatively lightly covered announcement from NYU Finance Professor Stephen Brown (with co-authors William Goetzmann from the Yale School of Management, Bing Liang from the University of Massachusetts at Amherst and Christopher Schwarz from the University of California at Irvine) that 1 in 5 hedge fund managers misrepresent funds and performance to investors.
For effect, let me repeat – 1 in 5.
“They found that hedge funds frequently misrepresent prior legal and regulatory problems (21 percent of cases) and provided incorrect or unverifiable representations about assets under management, performance and other topics (28 percent). Nine percent of the sample said they had no legal or regulatory problems when in fact they did, and six percent disclosed some problems, but not others.”
This is not the environment to play fast and loose with the facts or to be cute…or even to “round up” a .06. Integrity is back – managers need to prove that they are being truthful, the starting point is no longer the assumption that managers are telling the truth. Consider point 3
Article from Businesswire via Yahoo.
3. At our recent investor roundtable – 22 hedge fund managers, 12 investors – I received some startling feedback on the same issue. One of our more experienced investors systematically went through 5-6 funds and basically called out likely “fudging” of the truth. Examples included:
- Quarterly performance that was split monthly but not disclosed that way
- Melding of track records that were delineated on the performance chart but done in a way that one was in green, the other in a blue so that to the untrained eye, basically looked like the same track record
- Annualization of partial year returns
- Performance that was up in months where the strategy was clearly down was ”unbelievable…literally”
So here we have examples of one of the major firms caught insider trading, an academic study indicating that 1 in 5 managers misrepresent some aspect of their performance/pedigree and a personal first hand experience from one of our events where performance and lack of clarity raised immediate red flags.
Understand that whether you are guilty of some of these infractions or squeaky clean, the marketing environment just got a little more difficult. Investors have no choice but to paint the industry with a broad brush.
So what to do…?
- Be clear not coy – any questions or unclear points on the performance, strategy, background should be highlighted and explained. In this era of heightened (and empowered) operational due diligence, your flaws will be discovered soon enough.
- Fact-check performance – Is any of the performance open to interpretation? have you had your service providers review? have you had your investors review? You want your performance to be bullet proof.
- Prepare your responses – In the event that there are unclear aspects of background, AUM accumulation, performance, etc. make sure that you have a simple explanation ready. Do not go into meetings with the hope that these issues might be missed.