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Hedge funds: Rebuilding trust
Posted on April 27, 2010 at 07:48 PM

Bernie Madoff continues to cast a shadow over the hedge fund industry. "The presumption is of guilt, not innocence," said Anthony Scaramucci of SkyBridge Capital. He and other experts at a panel on hedge funds said investors are stepping up their due diligence, scouring the finances and personal histories of hedge funds and their managers as never before.

Scaramucci, for instance, routinely hires private investigators to check out people his firm hires to manage money. Recently, he learned that a well-regarded manager had lied about having graduated from UCLA. "Money will corrupt. Greed will corrupt. If we haven't learned that in the 2008 financial crisis, when are we going to learn that?"

Hans Hufschmid of GlobeOp Financial Services, which provides independent verification of the existence and pricing of assets hedge funds manage, said that that due diligence requests jumped 30 percent in 2009. "Hedge funds lost money through markets, a crook and bad credit," he noted. "The focus is on who the manager is doing business with, the firm's credit exposure and how it's all managed."

To gain more control over their assets, many investors are trying to set up managed accounts with hedge funds. Unlike pooled investments, assets in managed accounts are segregated from the hedge fund's main account. Investors control the account, leaving no doubt as to how the assets are performing. Yet few institutions have successfully converted to managed accounts because of the hassles involved in negotiating trading agreements and setting up risk-measurement systems, Hufschmid said.

Without a doubt, the relative immaturity of the hedge fund industry has contributed to investor jitters. Firms are typically small, with only one or two individuals calling the strategic shots. Derivatives and other instruments that hedge funds commonly trade also are not transacted openly, although that may change with financial reform legislation now pending in Congress.

Still, the lesson of Madoff is that there's no substitute for hard work. "We're always learning," said John Claisse of Albourne America, a firm that specializes in due diligence of hedge funds.