It's been a tough year for private equity

It's been a while since the Madoff news broke and it does sadden me to hear the news how a single person pulled off the largest Ponzi scheme known to mankind. I am tempted to say once again that it is all about trust - a money manager must trust his partners and partners must trust their money manager. However, the Madoff scheme appeared to have all the makings of lots of relationships built on solid trust. Perhaps too much trust.

Most of the investors that had money with Madoff had a personal connection to Mr. Madoff or someone who had this connection to allow access. Additionally, statements were produced backing up transactions and asset values. And people who wanted to get their money out were able to because there were so many other investors coming in. It is easy in hindsight to say that any vigilant investor should have seen the signs. However, all of these factors enabled the kind of trust that only a money manager could dream of - blind trust from investors.

Part of me is very distraught over Madoff because it paints a bad picture of the hedge fund industry. A picture of dishonesty and scandal. Another part of me is not distraught because the people that lost money with Madoff were either of the wealth that they can afford to lose money or they were stupid enough to put 100% of their net worth with a person that they did not know very well. With any financial investment there is risk and an investor must be willing to lose his entire investment. There was greed involved and this greed came in the form of investors willing to do anything for returns including trusting someone that they did not know well.

The silver lining to the Madoff scandal is that where there is carnage there is opportunity. When it is harder to start a hedge fund that means it is a better time to start one and to be in the business. There is less competition and only the very strong survive. These past few years have been a trying one for almost all of private equity - buyout funds getting bad press, venture capitalists with few exit opportunities, real estate values decreasing with tight credit, and hedge funds facing massive redemptions and loss of trust from investors.

But all things come in a cycle. These are the times when managers must dig deep and lean in and set things up for the next wave to come. And there is no doubt that another wave is coming - it may take a while. But, the economic policies being set forth to get us out of trouble will undoubtedly stoke a huge blaze in the other direction. Money flows to the best returns and right now the government is decreasing the rates of return on everything and driving money toward real estate and equity.

The recapitalization has taken place in the economy and the Madoff scandal just triggered the reset button for the hedge fund industry.

Comments

[Mark Reiboldt]

I agree that when it is harder to start a hedge fund, this will be a good time to do it, but there's the caveat that new hedge fund managers better have more to bring to the table than perhaps they needed in the last five years or so when everyone and their dog could start a new fund. I think these events (i.e., Madoff, housing crisis, bailouts, recession, etc) will humble hedge fund managers; it will reign in those who took unreasonable risk and weed out the poor managers who had no business doing what they were doing in the first place.