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More hedge funds may fail amid bets on Madoff

For years, hedge fund manager Sandra Manzke trusted Bernard Madoff to deliver steady returns for her clients. Instead he may have delivered a fatal blow to her business.

Manzke's Maxam Capital and other funds of hedge funds recommended that wealthy clients invest with Madoff and his feeder funds at a time when the portfolios recorded small but predictable returns and sparked envy because most other investments were losing money. Feeder funds invested accounts for Madoff.

Madoff told FBI agents last week that he had ran a fraudulent operation, according to U.S. officials. By that point, Manzke and managers at hedge funds Austin Capital Management, Fairfield Greenwich Group, Kingate Management, Tremont Capital and Union Bancaire Privee, realized they too had lost hundreds of millions, according to people who are familiar with the investments but spoke anonymously because they were not authorized to speak for the firms. The list of Madoff victims also included banks and many wealthy individuals.

Manzke could not be reached for comment.

“Tremont was victimized by not just a person but also a scheme and a complex process designed to deceive individuals and organizations, managers and analysts, including some of the largest, sophisticated financial institutions in the world,” said Monthieth Illingworth, a spokesman for Tremont.

Austin Capital invested money for the Massachusetts pension fund, which lost $12 million on Madoff, the state said.

Calls to the other groups were not returned.

According to industry lawyers, forensic accountants and former prosecutors, the Madoff investors missed some red flags. But other investors saw the warnings and steered clear of the prominent 70-year-old Madoff, who had a loyal following among the country club set in Palm Beach and New York.

Now at best, the fund of hedge fund managers who promised to spread investors' risk for a heavy fee by vetting a handful of individual funds, will have trouble wooing new clients.

At worst, some may fail. A fund of hedge funds is a basket of funds selected by the manager to spread around risk.

“Any person who has taken on a fiduciary responsibility and may have allocated significant amounts of money to Madoff or his direct affiliates will materially suffer reputational damage,” said Ron Geffner who works with many hedge funds and investors as a partner at law firm Sadis & Goldberg.

“And as a result we would expect they would have a difficult time soliciting new assets,” Geffner added.

No one can say exactly how many of the world's estimated 2,463 funds of hedge funds will collapse by the end of 2008. But the year is already destined to set new records for worst-ever performance, most funds to fail, and most money ever withdrawn, industry lawyers said.

In October alone, investors took out $22 billion from funds of funds, according to data from Hedge Fund Research.

But with so many funds of hedge funds having fallen for the prominent, well-connected Madoff, who waved off potential investor questions with a smile, the $1.5 trillion hedge fund industry will suffer another black eye, the lawyers said. 

One reason managers apparently did not suspect the alleged fraud was that they relied on the assurances of other middle men who insisted that all was well with Madoff's funds.

“Clearly everyone believed that someone else had done the due diligence. And by relying on some small firm that Madoff employed rather than a big independent auditor was clearly a mistake,” said one person who asked not to be identified because several clients lost money with Madoff and he was not permitted to speak publicly.

Also, industry lawyers and investors who steered clear of Madoff said his investors felt safe because he had operated for years and reported only five months of losses out of 156 months.

If he had been running a fraudulent operation, they reasoned, it would have come to light sooner.

The alleged fraud came only months after failed hedge fund Bayou Group's fraud made new headlines this summer when its manager Samuel Israel staged a fake suicide to avoid prison.

With the two cases, people may become a lot more careful in selecting funds, industry insiders said.

“Investors pay funds of hedge funds to screen, select and perform due diligence and portfolio construction services on their behalf,” said Philippe Bonnefoy, chairman of the asset allocation committee at Cedar Partners, an investment adviser. “In light of the Madoff fraud, the industry will be under pressure to prove to institutional investors that all these services are worth paying for.”

Source: Reuters

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