From the New York Times, September 4, 2005
Connect the Dots. Find the Fees.
Gretchen Morgensen
TO many investors, the collapse of the Bayou Group - a hedge fund company and brokerage firm run by Samuel Israel III - may seem like just another financial mishap, and a calamity only for those who had the bad luck to invest with Mr. Israel or to be steered his way by advisers they were wrong to trust.
But actually, the mess at Bayou, which federal prosecutors are now calling a $300 million fraud, should be a clarion call for caution among the many investors who have been throwing money at hedge funds recently. This is especially true for institutions - endowments and public pension plans - that have flocked to hedge funds with the hope of increasing their returns. Because many of these institutions are having financial difficulties - low interest rates are cutting deeply into their returns - they are too often captivated by investments that seem to promise outsized gains with little risk.
"Our unique multifactor risk model acts as a road map for navigating risk and provides investors with alternative routes to reach their investment summit," Steve Henderlite, a co-founder and principal of Trail Ridge Capital L.L.C., said in a press release from October 2003. Trail Ridge Capital is a hedge fund and fund-of-funds company that had clients in Bayou. Mr. Henderlite did not return a phone call seeking comment.
Trail Ridge is also an adviser to a new investment fund, the Undiscovered Managers Spinnaker Fund, offered to wealthy individuals by the investment unit of J. P. Morgan Chase. The fund, which started last November and had $7.3 million in assets as of March 31, held $662,602 in Bayou. J. P. Morgan says it has written that investment down to zero.
Central to the Bayou story, and to almost every other financial disaster of recent years, are conflicts of interest. At Bayou, these conflicts began in its brokerage unit, which executed trades for the hedge funds. Because the brokerage unit, Bayou Securities, was wholly owned by Mr. Israel, he was able to profit personally from the rapid-fire trading conducted by the funds he oversaw.
But some Bayou investors who got into the funds on the recommendation of investment consultants were confronted with another layer of conflicts. That is, the consultants who recommended the hedge funds to their clients and the funds of funds that bought Bayou shares for their investors often received compensation from Bayou for sending assets its way.
While some investors may not find fault with such an arrangement, institutional investors who have a fiduciary duty to their beneficiaries should definitely steer clear of the deals.
"In my view, if a hedge fund manager wants to pay a particular level of fees to a marketing agent, that's their business," said Orin Kramer, chairman of the New Jersey Investment Council, the oversight board for the state's pension system. "But as a fiduciary, I would be very uncomfortable dealing with a gatekeeper who is being paid on both sides of the trade."
Unfortunately, not all fiduciaries know where these conflicts lie. They are often well hidden.
"Pension consultants frequently have undisclosed financial arrangements with hedge fund managers that create a conflict of interest," said Edward A. H. Siedle, president of Benchmark Financial Services, in Ocean Ridge, Fla., a company that works for pension funds to investigate possible wrongdoing among outside money managers.
Mr. Siedle says the nature of these deals varies. Sometimes the payments come in the form of commissions on trades steered by a hedge fund to a brokerage firm that is affiliated with the consultant; in other cases the payments are fees paid by the fund based on the assets the consultant brings in. In one case, Mr. Siedle said, he found that a pension consultant received a partnership interest in the hedge fund to which it was steering clients.
SUCH payments were a part of the picture at Bayou. According to materials provided by the fund to a prospective investor in 2003, Bayou had several outside marketers that it paid either as a percentage of assets raised or through commissions to the promoters' "designated broker/dealer."
One of the firms that Bayou listed as an external promoter at that time was the Consulting Services Group of Memphis. Bayou also gave prospective investors the name of E. Lee Giovannetti, chief executive of Consulting Services, as a reference and as an institutional investor in Bayou.
Joe Meals, a spokesman for Consulting Services, said that the firm did act as a reference for Bayou in 2003 and that it had recommended Bayou funds to clients. But, he said, "We became uncomfortable with the operations at Bayou and made recommendations to all our clients that they redeem their accounts, and they did so long before any of these issues came to light." He added that Bayou "may have executed commissions through our affiliated broker dealer at one time, but not recently."
Consulting Services did the right thing in advising its clients to exit Bayou before the debacle. Others weren't so lucky.
In coming weeks, federal and state investigators will try to sort out what happened to the money that investors entrusted to Bayou. Because Bayou's minimum-investment requirement of $250,000 was smaller than that of most hedge funds, the firm unfortunately attracted a lot of individual investors. The United States attorney in New York is seeking the forfeiture of all of Bayou's assets, including $100 million seized by authorities in Arizona last May. How much Bayou's investors ultimately get back is anybody's guess.
Larger investors, especially those who are fiduciaries, should take a lesson from the losses at Bayou. Conflicts of interest in the financial world are often hard to uncover. But refusing to do the necessary digging is downright irresponsible.
Copyright 2005 The New York Times Company
|
|
|||
|
Monday, September 5
by
nadezhda
on Mon 05 Sep 2005 06:17 PM EDT
Monday, August 29
by
nadezhda
on Mon 29 Aug 2005 09:07 PM EDT
That's the question that Buttonwood asks in the Economist. And provides an interesting roundup of evidence that many emerging markets aren't as vulnerable as they were when the Asian crisis hit, with follow-on waves of Russian and Latin American contagion.
In addition to the benefits of having pursued sounder macropolicies, the emerging markets as a group are enjoying a far healthier composition of the money that's been pouring into emerging markets assets recently, attracted by better returns than in more developed markets.
Buttonwood speculates on what might generate changes in investor sentiment: But it would not take much to produce that—higher real interest rates in America, for a start (and rate rises look likely to continue). The impact of dearer oil is harder to judge. High oil prices should be a plus for emerging producers such as Russia and Venezuela, while heavy importers such as South Korea have enough other attractions to get away with it. But money managers are beginning to look askance at emerging-market guzzlers who have subsidised energy use and may no longer be able to afford it. [Brad Setser has an interesting post on the differential impact of rising oil prices on various emerging markets] Yet for those of us who have long followed the emerging markets, it's hard not to be hopeful that this time it's different in the sense that hard-won gains in attracting long-term investment won't be wiped out by another round of emerging markets contagion. At the very least, a more mature market for emerging markets assets may produce greater discrimination by investors among countries when the inevitable turn in sentiment arrives. As Buttonwood concludes: The broad picture is nonetheless revealing, and, within limits, encouraging: a sell-off rather than a rout may be the worst that happens if foreign investors turn tail. Of course, all bets are off if long-delayed global adjustments -- with the US deficits at the center of the process -- produce the end of the current "Bretton Woods II" regime, as discussed by Nouriel Roubini and Brad Setser. Few emerging markets, regardless of their reserve positions or low portfolio liabilities, will find themselves unscathed in that scenario. Wednesday, March 2
by
nadezhda
on Wed 02 Mar 2005 03:42 PM EST
I follow the global capital markets broadly but not closely. Like the Brads (Setser and DeLong), Tyler Cowen and General Glut (or for that matter, Warren Buffett), I've been increasingly concerned for more than a year about the unsustainability of foreign central bank financing of the US current account. But I don't bother to comment on the problem -- there are far more knowledgeable folks out there doing an excellent job tracking and analyzing both the macro and the micro numbers, and they agree in some areas and disagree in others.
Although I'm an enthusiastic reader of all this stuff, when it comes time to sort it all out for myself, I find I fall back on some far simpler heuristics. It's a kind of informal "severe storm warning" indicator system that the world is in fact awash in liquidity, and the shake-out is coming sooner rather than later. Unfortunately, I've just seen the final signals flash. Here's what I said in mid-January, in a comment on the blog Investor's Diary: My simple rule of thumb used to be: the moment you see the investment banks trot out something that looks like a "perpetual" and they find someone to buy them, it's time to run for the hills because a bubble is about to burst in the debt markets spread across most classes of financial assets. There is no way that risk is being priced in -- the premium is too skinny. When spreads are too skinny means the world is awash in excess liquidity looking for returns. And none of the monetary authorities in the major countries has the incentive or disciplined to mop it up that liquidity. And now come the clinchers in my personal severe storm warning system:
Fundamentally, all of this is a sign of way, way, way too much liquidity. It's going to get wrung out of the system one way or the other, and it's going to be the debt markets where the contagion (across asset classes and across currencies) is going to happen. I'm afraid this time around that this is not simply going to be a case of a "condition [that] gets easily rectified by the Fed merely turning the spigot off" because of the various policy traps the Fed finds itself in. If those thoughts haven't made you lose your appetite for thinking about the capital markets, here are some other links of possible interest, including some further perspectives on what's maintaining the gravity-defying asset bubbles we've been witnessing. But warning, even the experts who see the global financial system entering dangerous waters don't agree on what it all signifies let alone what's going to happen. Two of my favorite reads on the markets -- one daily, one monthly -- are at the opposite end of the size spectrum. One has more of a trader's view, the other a portfolio manager's view. Investor's Diary is a recent blog by an individual trader in Bunds who writes about the other markets he follows closely but doesn't trade in (especially these days FX, treasuries, financials and oil). The other is the monthly column by the chief bond guy at the big portfolio manager PIMCO, Bill Gross -- BTW the other articles and publications on the PIMCO site are also worth a read.
Just found that General Glut thought the French 50-year bond noteworthy as well when it was announced last month. Monday, January 24
by
praktike
on Mon 24 Jan 2005 06:29 PM EST
I guess that's the last time Bill Thomas goes on Meet the Press ... this was in my inbox today (below the jump):
{UPDATE 1-25-04} by nadezhda: Also after the jump, my response to what was a perfectly civil and innocuous query from praktike. Just in case anyone was losing sleep over what I think about Social Security and how it fits more broadly into "what should be done" in the economic and social policy arena, you can learn everything you ever wanted to know and were afraid to ask. more » Tuesday, November 16
by
nadezhda
on Tue 16 Nov 2004 11:13 AM EST
Courtesy the Washington Post, another installment in the saga of the shift in the balance of economic risk away from capital and toward labor. This time brought to us by the Pension Benefits Guaranty Corporation.
A significant portion of the skyrocketing deficits is due to declared or likely-to-be bankruptcies in the airlines and steel industries. Deregulation of airlines may have expanded services and reduced the price of flying for us as consumers, but it looks like we may be picking up some of the tab as taxpayers.
Oh, and perhaps we should consider this little item when we're figuring out how to fund the transition cost of privatizing part of Social Security. Although it must be admitted, $20+ billion is easy to overlook when you're talking in fractions of a trillion. Struggling under a cascade of bankruptcy filings in the airline and steel industries, the government's pension insurance agency said yesterday that its deficit has more than doubled in the past year -- to $23.3 billion.There are three basic ways that the deficit can be made up: (1) revaluation of assets through a bull market (combined with some "aggressive" portfolio management); (2) increasing revenues through larger premium payments from employers; and (3) taxpayers making up the difference. Door Number 1 isn't what you'd want to bet the farm on, as hopefully someone learned in 2000. more » Sunday, October 31
by
nadezhda
on Sun 31 Oct 2004 06:49 PM EST
So says Steve Pearlstein, and he assembles a pretty long list of troublesome points. I don't know about you, but between oil prices likely to remain at over $50 a barrel and a current account deficit on an upward path toward 6% of GDP , I'm starting to get a little antsy about, say, interest rates and growth rates going in the opposite (wrong) directions in the medium-term that don't have anything to do with the business cycle.
[UPDATE 10-31-04] by nadezhda Seems I'm not the only one fretting. See below the fold. more » |
Recent Articles
Blogging making reporters more relevantIgnatius and Zakaria - new WaPo joint venture Reasserting US Hegemony: Russian rollback, Chinese containment and Iranian regime change What's up A "paddling" of lame ducks? Voices of the New Arab Public Time for a post-post-9/11 world? "V" is for Victory and "C" is for Caliphate Times' timing Bolton's ba-a-a-ack! -- and how you can act (updated) More reactions to Krauthammer et al "Let ambition counter ambition" America's own "disappeared" Congress and the "disappeared" The diplomatic politics of polarization
The Satin Pajama
NOMINEE Best non-Euro Blog
The first afoe European weblog awardsSponsored by A Fistful of Euros Hey, we didn't win, but we almost beat out the Head Heeb for 2nd place! Thanks for the votes Click here for a really slick page of results and links to all the nominees in 18 different categories -- some wonderful blogs to explore, so check them out! Search
Month Archive
Login
|
||
|
|
|||

In a study released last week, Christian Stracke of CreditSights, a research firm, compares emerging economies’ dependence on portfolio inflows now and eight years ago. (Portfolio investment—as opposed to foreign direct investment—is generally fast and easy to liquidate, and so includes the sort of “hot money” that travels fast and upsettingly.) Looking at 25 countries, he finds that dependence is generally much lower, but patchily so.
A significant portion of the skyrocketing deficits is due to declared or likely-to-be bankruptcies in the airlines and steel industries. Deregulation of airlines may have expanded services and reduced the price of flying for us as consumers, but it looks like we may be picking up some of the tab as taxpayers.
The first afoe European weblog awards