PE vs. Tremont

A major worry for those who make their living in the private equity industry is that institutions will sour on the asset class as a deliverer of performance.

In particular, the upcoming round of heart-stopping write-downs may convince the boards who oversee private equity investment programmes that GPs, on average, aren’t the Gods of Alpha promised in the consulting sermon.

Not to worry – private equity, like Churchill’s democracy, is (currently) a horrible asset class, but it’s better than everything else. Debt? Forget about it. Stocks? Gone to Hades.

Now over to “alternatives”.  Infrastructure? Intriguing, but which institution has enough track record in this niche to shed light on the future? Real estate? Typhoid Mary.

Hedge funds? Now there’s an interesting question. As with private equity, institutions are going through a major reassessment of this loosely defined asset class. Private equity’s exposed weakness is that, with the application of fair value, it does in fact track the public markets, thanks to public-market comparables. It may in the long term deliver outperformance but in the short term it’s down in the dumps with the S&P 500 (plus the extra baggage of massive leverage and an overdose exposure to the consumer sector).

But hedge funds have it worse. Institutions were already having a hard time figuring out which bucket to throw this asset class in (Is it equity? Alternatives?) Now another mystery has complicated the performance-assessment equation – to what extent did the Bernard Madoff fraud overstate historic average hedge fund returns? A widely followed hedge fund index won’t say.

According to the Credit Suisse/Tremont Hedge Fund Index, which recently and suddenly marked to zero Madoff-linked funds identified as “Kingate Global/Fairfield Sentry”, dong so crushed the Equity Market Neutral sub-index by an immediate 40.45 percent. Credit Suisse/Tremont takes its brand in part from Tremont Capital Management, the Rye, New York fund of hedge funds manager that may have lost $3.1 billion of investor money to the Madoff scandal.

A spokesperson for Tremont Capital did not respond to an inquiry into Madoff’s impact on the broader Tremont index (which is not managed by Tremont Capital). A spokesperson for Credit Suisse/Tremont said that while the firm has disclosed the Madoff hit to its November Market Neutral figures, its policy did not allow it to look backwards and recalculate its historic index numbers minus Madoff.

It therefore remains unknown to what extent the absence of Madoff’s fraudulently strong numbers have affected hedge fund benchmarks over the years. But a 2001 article from hedge fund periodical MAR/Hedge partially reveals the extent of Madoff’s influence over hedge fund performance. An excerpt: “Madoff has reported positive returns for the last 11-plus years in assets managed on behalf of the feeder fund known as Fairfield Sentry, which in providing capital for the program since 1989 has been doing it longer than any of the other feeder funds.”

Private equity is in for a drubbing, but among the charges leveled against it, complete fabrication of returns will not be one. When asset allocations are reset again, private equity may gain on hedge fund pain, because quite simply it may appear to have performed better.