The alleged $50bn (£30.7) fraud, in which veteran financier Bernard Madoff’s seemingly successful hedge fund was apparently a “Ponzi” pyramid selling scheme, has been described as the biggest financial scandal of recent years. But how will British investors be affected? The following Q&As should provide more information.
How many banks have been caught out by this alleged fraud?
Royal Bank of Scotland has said it could lose up to £400m in the allegedly fraudulent fund, while Santander – which owns Abbey, Alliance & Leicester and part of Bradford & Bingley – has admitted that one of its investment funds had $3.1bn (£1.9bn) invested in the firm run by Mr Madoff.
In addition, two investment companies have money tied up in this business. Man Group, the London-listed hedge fund, said it had about $360m invested, and Bramdean Alternatives, run by “City superwoman” Nicola Horlick, has £21m invested with Mr Madoff.
So how many investors are affected?
Only a very small number of British investors are affected. In the vast majority of cases the money has been raised from institutional investors.
RBS, for example, said it had exposure through trading and lending to funds of hedge funds invested with Mr Madoff. If the value of these assets is nil it will have to write off the loans. But while this will hit profits at RBS, its customers are not directly affected.
Similarly, Abbey, A&L and B&B customers will not by hit. Santander said it had sold the affected investment fund to private banking clients, but only through its Santander branches in Spain. This fund was not sold through the Abbey network. Man Group said its exposure is through its RMF institutional fund and represents just 0.5pc of its total funds.
Bramdean’s investors in its Alternative Portfolio will see the value of this fund fall, as investments with Mr Madoff’s fund accounted for 9.5pc of its assets. However, Ms Horlick pointed out that even in the worst case scenario – the value of these assets falling to zero – the portfolio would show a loss of just 4pc over the course of the year, as other assets had performed strongly.
Investors who have bought funds that track the FTSE100 or All-Share index, for example, are sitting are far more substantial losses. Bramdean Alternatives was mainly targeted at higher-net worth individuals with portfolios of at least £100,000.
I hold bank shares – won’t they be affected by this news?
Abbey shareholders (many of whom had held the shares since the Abbey building society demutualised) were offered Santander shares, listed on the Spanish stock exchange, when the bank was bought by its larger European rival in 2004.
But Santander shares, like RBS shares, have not been adversely affected by today’s announcement. At lunchtime, shares in RBS and Man Group had risen slightly on the London Stock Exchange, while Santander’s had fallen by less than 0.5pc.
Investors seem confident that these companies can absorb the losses without much of an impact on their balance sheet.
Are other hedge funds likely to be affected?
More and more private investors in Britain have money invested in hedge funds – often through a “fund of funds” structure, which is designed to minimise risks.
Originally these funds were the preserve of high-rollers with at least £50,000 to invest. But as the minimum investments have fallen, these markets have opened up to a wider audience. In addition, the remit of the vast majority of hedge funds – to make absolute returns in both falling and rising markets – has enticed many private investors to try them.
However, as it is alleged that the problems at Mr Madoff’s fund were caused by fraud rather than market conditions, it seems unlikely that they will have a knock-on effect on other hedge funds – unless, that is, they too have money invested with Mr Madoff.
Are all hedge funds high risk?
There are many different types of hedge fund and many very different investment strategies. Some managers “short-sell” stocks to try to generate money from falling markets; others “arbitrage” to exploit small price differentials across different markets and currencies. Many hedge funds will use all these techniques.
While some are very high risk, others claim to be relatively low risk and therefore a “hedge” against more conventional equity investments. The problem for investors – and professional managers too – is identifying which funds are low risk and which are high risk, as hedge funds are not as tightly regulated as conventional unit trusts.
Many are located in offshore jurisdictions and can be very secretive about the investment strategies used to achieve their returns. In this case, for example, the Madoff fund was seen as being a relatively low-risk hedge fund.