Research from the NYU Stern School of Business based on confidential due diligence reports indicates that hedge fund managers often lie about the amount of money in their funds, how well they performed and regulatory and legal history. According to the recent study, nearly 20% of the information contained in the due diligence reports conflicted with what the hedge fund managers were saying about their funds. Assets could not be verified by alternative sources, performance couldn’t be verified and managers that were interviewed had difficulty recalling basic information about their level of assets and performance.
To be fair, most hedge funds have difficult-to-value investments, which makes the valuation process challenging. However, the valuations are being set by people who are paid based on a percentage of profits, so a grain of salt is necessary when reviewing a fund’s statements about their performance. This is particularly true in light of the number of funds that have been revealed to be Ponzi schemes over the last year.
Whether you are an individual investor or a fund of fund manager, it is vital to execute proper due diligence prior to investing in a fund. In addition to the necessity of vetting the information provided by a potential fund, you also need to look at other aspects of a fund like their back office functions and service providers and the fund’s relationship with their prime broker. For example, funds that were using Lehman as their sole prime broker were cut off from their money when Lehman went under, even if their investments were performing well. Additionally, there will surely be new government regulations regarding the due diligence that must be done prior to investing. There will be more responsibility placed upon money managers, banks and investment funds to make sure that they are not investing with fraudsters and stiffer penalties for not doing so.
Now more than ever, it is essential that you mitigate your risk by finding out as much about the companies that you are doing business with and investing in as possible. As investors struggle to recover from the recession and losses from poorly performing investments, any additional losses could be catastrophic.