Who Invested with Madoff? A Flash Analysis of Funds of Funds

Abstract

Financial fraud in general and Ponzi Schemes in particular continue to both fascinate and plague investors. A Ponzi scheme is often described as a securities fraud in which the promoter makes a false or misleading statement about his investment strategy and money from new investors is used to fund redemptions. When new investors cannot be found to offset investors asking to leave, current investors often are exposed to extreme loss of capital. This article examines whether funds of funds that invested with Madoff have any common characteristics. This question is of particular importance to the end investor, who has historically relied on the FOF industry to provide both manager selection and due diligence services. The results of this study should help investors and their consultants better identify those intermediaries that are less-well-poised to deliver investment management services with respect to hedge funds. The article analyzes a set of FOFs that were or were not invested with Madoff. The results show some relatively weak commonalities in the empirical characteristics of FOFs that invested in Madoff. Unfortunately, the apparent commonalities are insufficient in themselves to accurately and effectively predict which FOFs sought and acquired exposure to Madoff.