December 17, 2017

How to Avoid the Next Madoff

Bernard Madoff

While many are still waiting to get their money back from Bernie Madoff, more still are waiting for the movie to come out already.

“Madoff with the Money.” It’s one of the worst puns I’ve heard but it’s one of many book titles about Bernie Madoff and his scandal that robbed thousands of people of billions of dollars. There’s a lot of interest there. Barron’s has timeless advice for a question many hedge fund investors have: How to avoid the next Madoff. Erin E. Avedlund sums up the danger signs:

Amaranth, Long-Term Capital, and Madoff Investment Securities were all hedge-fund accidents waiting to happen. And all gave off visible warning signs that investors could have seen.

So argues the Greenwich Roundtable in “Avoiding Mistakes” (greenwichroundtable.org). The nonprofit education group highlights 22 case studies of unnamed, failed hedge funds and shows how to recognize signs of impending doom.

A chart—A Taxonomy of Hedge Fund Accidents—offers due-diligence checklists, including background checks and reviews of service providers, such as fund administrators. Some red flags: an inadequate track record, lack of independent valuation, poor risk management, multiple marketing firms, and hard-to-understand strategies.

Once investors commit money to a hedge fund, they should watch for excessive leverage, liquidity problems, concentrated positions, unreasonable volatility, inadequate transparency, hubris, inexplicable performance numbers, style drift, rapid growth, back-office problems, and poor staff dynamics.

So the self-protection begins before you invest in a hedge fund and is an ongoing process. A more boring book title may save readers time: How to Avoid the Next Madoff: Due Diligence.

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