Your May 27 story on the collapse of Abraaj harked back to the Bernie Madoff scandal some 10 years ago, when "the hedge fund world changed" and investors demanded more transparency. In the next paragraph, the story went on to say that Abraaj could be a catalyst for investors to demand independent oversight over their private equity portfolios.
Based on my experience, however, the problems with Mr. Madoff — even through a fund of funds — was neither a lack of transparency nor a lack of independent oversight. In fact, the problems were there to see for those who carefully looked in from the outside.
As of 2008, I was president of an investment consulting and independent fiduciary firm called Independent Fiduciary Services Inc. (later acquired by Gallagher Fiduciary Advisors LLC). At that point we evaluated one particular hedge fund of funds as a potential investment for one of our multibillion-dollar clients. Our analysis focused on the fund-of-funds general partner, not the many underlying hedge funds, including the GP's staffing, portfolio construction, due diligence processes, ongoing monitoring and additional matters. However, even with that focus, we inevitably considered a select few of the underlying funds, including Mr. Madoff's, because they raised questions about the GP's processes.
As I recall, the GP's maximum position limit for each underlying fund was supposedly 5% of the portfolio. Yet Mr. Madoff and his "split-strike conversion" strategy materially exceeded that limit and we asked why. The answer — conveyed in a memorable email — was that the GP had invested for years with Mr. Madoff, his strategy was time-tested and consequently, he was one of the GP's "high conviction" managers. That response caused us to look more deeply into the split-strike conversion strategy and to puzzle over how its pattern of returns was remarkably smooth and steady. That raised further questions. Indeed, each Q&A became hydra-headed, with each answer only raising more questions.
As we continued trying to get to final, satisfactory answers, events overtook: Mr. Madoff's fund exploded, the fraud was revealed and, of course, we never proceeded with the investment in the fund of funds. After Mr. Madoff was tried, convicted and sent to prison for the rest of his life, the memorable phrase "high conviction" took on new meaning.
Perhaps calls for independent oversight are now well-placed in light of Abraaj. But I believe that citing Mr. Madoff for that proposition misses the mark.
Samuel Halpern is principal of Prudent Expert LLC.
