Japanese Caught Up in Madoff Madness
"There must be more to life than having everthing!"
Maurice Sendak, 1967 from Higglety, Pigglety Pop!
Japanese institutional investors are believed to have suffered badly in one or more of the Madoff products that were marketed to them in recent years. Their exposure is likely to have been US$3-4 billion or maybe even as much as US$7-8 billion if trust banks or consultants had had enough time to direct the hoards of yield hungry Japanese pension funds.
The reality is, most losers are likely to have been investors of firms like Nomura investing proprietary monies, or worse still levering up investments of their HNWIs. In this case the revenue model would have been an up-front load (maybe 2-3% of assets) then a charge for the borrowed funds used to buy into the investment. It is also conceivable that the investor also paid a performance fee too, to Nomura! Clearly, with fees from selling Madoff's "investment" likely to have been as high as 6-7% of assets this was a lucrative "pump and dump" type of scheme.
It is a shame that Japanese individual investors will have to endure a lot of shame in this. Nomura and firms like it should be the ones covered in shame. Ideally, some brave soul should step forward with a Nomura prospectus that shows clearly just how much money Nomura was compensated in the marketing process. All products should have their fees clearly delineated on in investor-friendly adn accessible website. Let there be greater transparency on fees paid!
You can bet that the phone lines from Tokyo to New York and Connecticut were jammed when news hit the wires of the fraud on December 11th!
From an estimated peak of about US$65-70 billion of invested assets in single managers and fund of hedge funds a few years ago Japanese institutional investors have been pulling back from hedge fund products to under a third of that today. After Madoff the contraction is likely speed up.
The reasons were numerous. First, there was the issue of performance. A lot of Asia-regional products had effectively imploded starting with the Japanese focused ones from 2006 onward. The broader Asia-madate managers started to really tank in 2007.
Second, there had been a regulatory consideration (Basel II) that cut sharply the appetite for hedge funds by most financial institutions.
Third, the impact of Subprime Syndrome convinced many investment committees that the marketing pitch of diversification was not reliable or realistic in times of market stress. Aside from hitting hard fixed income arbitrage managers and those that with credit market exposure it also cut demand for many multi-strategy hedge fund of funds that had sold well in the good times on the basis of "name" and "brand". Once performance dipped on these products to below 5% the benefit to Japanese end-investors became questionable, especially in a falling foreign currency denominated product!
Fourth, many Japanese also pulled back investments in toxic structured products when these also fell sharply in value beginnning in the summer of 2007.
The Madoff product was a natural "winner" among weary Japanese investors. It fulfilled many superficial bureaucratic checks that a lot of institutional investor blindly followed: it had a long track record (10+ years); it had the "backing" of established companies who surely had done their own on the ground due diligence (at least visiting the premises once per year); it had an apparently appealing investment story which needs to be really ease to understand or really complex (in this case, complex; it was too big to fail (somehow size always is considered a positive and never a negative); and then, there were those impressive, non-correlated returns that offered an apparent yield of 700-900 bps over LIBOR - attractive to fixed income investors. Some Florida retirees referred to this as their "Madoff bond"!
The Madoff Madness that has erupted should teach Japanese institutional investors a number of lessons. First, hedge fund of fund firms (regardless of name, reputation or size) are no panacea for averting fraud in the industry. In fact, it could be argued that the bigger tyhe firm the more likely the process problems sith catching "problem managers". Second, if performance numbers look good to be true, they often are. Third, if the strategy takes longer than 2 minutes to understand chances are it is riskier than you think!
Fourth, every entity along the hedge fund distribution value chain should be incentivized to take responsbility for short term due diligence as well as longer term performance. Maybe a fixed fee should be imposed with a clawback dependent on various time/performance markers.
Why should a marketer care about the origins of those returns, and how is it that only the end investor loses out in the final analysis? Intermedaries collected their fees and paid their sales teams!
More risk (financial and legal) needs to fall on intermediaries and sales in order to unclog these conflicts of interest and impose responsibility where it belongs. Perhaps, investors should demand that the intermediaries also invest in the same products (and share classes) that they are peddling?
Now, Japanese investors should use the recent Madoff Madness as an opportunity, not to shy from all hedge fund strategies. That does not make sense. Instead, they should stand tall and negotiate responsibility from marketers of these products including deciding not so much how much fees are paid but rather when those fees are paid out. There should be benchmarks and deferred fee agendas to ensure that the interests of the marketers are more closely matched with those of the investors.
Finally, the Japanese investors themselves need to be more professional; they need to hire, retain and pay specialists (real market rates) to ultimately invest directly into hedge fund managers in much the same way that the US endowments and other global allocators are doing. The days of running their financial/investment arms from the HR or General Affairs departments are over. I am sure that this argument has been raised many times in the past. Mahalo.
"There must be more to life than having everthing!"
Maurice Sendak, 1967 from Higglety, Pigglety Pop!
Japanese institutional investors are believed to have suffered badly in one or more of the Madoff products that were marketed to them in recent years. Their exposure is likely to have been US$3-4 billion or maybe even as much as US$7-8 billion if trust banks or consultants had had enough time to direct the hoards of yield hungry Japanese pension funds.
The reality is, most losers are likely to have been investors of firms like Nomura investing proprietary monies, or worse still levering up investments of their HNWIs. In this case the revenue model would have been an up-front load (maybe 2-3% of assets) then a charge for the borrowed funds used to buy into the investment. It is also conceivable that the investor also paid a performance fee too, to Nomura! Clearly, with fees from selling Madoff's "investment" likely to have been as high as 6-7% of assets this was a lucrative "pump and dump" type of scheme.
It is a shame that Japanese individual investors will have to endure a lot of shame in this. Nomura and firms like it should be the ones covered in shame. Ideally, some brave soul should step forward with a Nomura prospectus that shows clearly just how much money Nomura was compensated in the marketing process. All products should have their fees clearly delineated on in investor-friendly adn accessible website. Let there be greater transparency on fees paid!
You can bet that the phone lines from Tokyo to New York and Connecticut were jammed when news hit the wires of the fraud on December 11th!
From an estimated peak of about US$65-70 billion of invested assets in single managers and fund of hedge funds a few years ago Japanese institutional investors have been pulling back from hedge fund products to under a third of that today. After Madoff the contraction is likely speed up.
The reasons were numerous. First, there was the issue of performance. A lot of Asia-regional products had effectively imploded starting with the Japanese focused ones from 2006 onward. The broader Asia-madate managers started to really tank in 2007.
Second, there had been a regulatory consideration (Basel II) that cut sharply the appetite for hedge funds by most financial institutions.
Third, the impact of Subprime Syndrome convinced many investment committees that the marketing pitch of diversification was not reliable or realistic in times of market stress. Aside from hitting hard fixed income arbitrage managers and those that with credit market exposure it also cut demand for many multi-strategy hedge fund of funds that had sold well in the good times on the basis of "name" and "brand". Once performance dipped on these products to below 5% the benefit to Japanese end-investors became questionable, especially in a falling foreign currency denominated product!
Fourth, many Japanese also pulled back investments in toxic structured products when these also fell sharply in value beginnning in the summer of 2007.
The Madoff product was a natural "winner" among weary Japanese investors. It fulfilled many superficial bureaucratic checks that a lot of institutional investor blindly followed: it had a long track record (10+ years); it had the "backing" of established companies who surely had done their own on the ground due diligence (at least visiting the premises once per year); it had an apparently appealing investment story which needs to be really ease to understand or really complex (in this case, complex; it was too big to fail (somehow size always is considered a positive and never a negative); and then, there were those impressive, non-correlated returns that offered an apparent yield of 700-900 bps over LIBOR - attractive to fixed income investors. Some Florida retirees referred to this as their "Madoff bond"!
The Madoff Madness that has erupted should teach Japanese institutional investors a number of lessons. First, hedge fund of fund firms (regardless of name, reputation or size) are no panacea for averting fraud in the industry. In fact, it could be argued that the bigger tyhe firm the more likely the process problems sith catching "problem managers". Second, if performance numbers look good to be true, they often are. Third, if the strategy takes longer than 2 minutes to understand chances are it is riskier than you think!
Fourth, every entity along the hedge fund distribution value chain should be incentivized to take responsbility for short term due diligence as well as longer term performance. Maybe a fixed fee should be imposed with a clawback dependent on various time/performance markers.
Why should a marketer care about the origins of those returns, and how is it that only the end investor loses out in the final analysis? Intermedaries collected their fees and paid their sales teams!
More risk (financial and legal) needs to fall on intermediaries and sales in order to unclog these conflicts of interest and impose responsibility where it belongs. Perhaps, investors should demand that the intermediaries also invest in the same products (and share classes) that they are peddling?
Now, Japanese investors should use the recent Madoff Madness as an opportunity, not to shy from all hedge fund strategies. That does not make sense. Instead, they should stand tall and negotiate responsibility from marketers of these products including deciding not so much how much fees are paid but rather when those fees are paid out. There should be benchmarks and deferred fee agendas to ensure that the interests of the marketers are more closely matched with those of the investors.
Finally, the Japanese investors themselves need to be more professional; they need to hire, retain and pay specialists (real market rates) to ultimately invest directly into hedge fund managers in much the same way that the US endowments and other global allocators are doing. The days of running their financial/investment arms from the HR or General Affairs departments are over. I am sure that this argument has been raised many times in the past. Mahalo.
posted by Franklin Scruggins | 7:23 AM
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