Thursday, December 18, 2008

Robust and thorough due diligence is back

Bramdean Asset Management (Nicola Horlick’s business) used to have this line on its website:

Robust and thorough due diligence is at the heart of our firm's investment process. Our detailed manager monitoring programme ensures that our clients' investments are subject to on-going and effective governance.

I pointed out the incongruity between that line and the substantial investment in Bernie Madoff’s fund. 

Within hours “robust and thorough due diligence” was unfashionable – having being dropped from Bramdean’s site.  Nicola Horlick was – consistent with her BBC appearances – insisting that the due diligence failures were the fault of the SEC.  [As anyone with long experience knows the SEC is useless – but Nicola Horlick discovered that only last week.]

Anyway – it appears that “robust and thorough due diligence” is back in fashion.  Bramdean’s site now contains the following paragraphs which are consistent with both the prospectus of Bramdean alternatives and statements made to the stock exchange.  

Robust and thorough due diligence is at the heart of our firm's investment process. Our detailed manager monitoring programme ensures that our clients' investments are subject to on-going and effective governance. Our investment process includes a number of meetings with managers, carrying out on-site visits, as well as off-site analysis. Research reports are prepared for proposed investments and these are presented to the firm's investment committee. That committee has to approve all investments.

We report transparently and regularly to our clients and investors. In regard to Bramdean Alternatives Limited we produce a monthly Factsheet in addition to our regulatory reports which are prepared at the half-year and full-year end. We provide details about the portfolio, the asset allocation and the geographical allocation on, which is updated every month following the release of the month-end net asset value.

Anyway lets examine what that due diligence entailed.  There were two holdings in the Bramdean Alternatives accounts that were described completely differently.  These were Rye Select and Defender.

Here is how the last Bramdean Alternatives annual report described Rye:

Rye Select Broad Market XL portfolio Ltd
Strategy Derivative Arbitrage
Fund size US$330 million
Portfolio Weighting 3.49%

The Fund was launched in September 2006, although the manager has many decades of experience in executing the underlying strategy. The Fund is a relative value fund which specialises in derivative arbitrage and index trades.

The Rye Select portfolio is a three-times leveraged version of a very conservative split-strike strategy – which consists of the purchase of a basket of equities, the purchase of a put option and the sale of a call option. The strategy has provided steady incremental profits for the portfolio over the period. During the months that the manager felt there were no sufficient investments to take advantage of, it remained in cash.  The cost of leverage normally outweighed the interest from the capital during these months.

And here is how Bramdean Alternatives described Defender Ltd

Defender Ltd.
Strategy Relative Value
Fund size US$382 million
Portfolio Weighting 4.18%

This Fund was established in May 2007 and the manager, Reliance Management BVI Ltd., currently employs, via its subsidiaries and affiliates, 17 employees with two key principals: Linda Wayman and David Whitehead.

The majority of the Fund’s assets are traded by Bernard L. Madoff Securities LLC, based on a trading authorisation agreement with the Fund. Madoff Securities is a leading international market-maker in all of the S&P 500 stocks. Madoff Securities is also a leader in the U.S. ‘third market’ which trades U.S. listed equities away from the exchange floor.  Based on the trading authorisation with the Fund, Madoff Securities implements a strategy that consists of a long position in a basket of S&P 100 shares and an index option strategy against these shares (bull spread). Madoff Securities will only enter into this trade if it believes that it can profit.  Otherwise, the money is invested in U.S. Treasury-bills.
The Company invests in this low-risk, high-liquidity fund as a vehicle to provide short-term liquidity to fund private equity capital calls. The Fund is continuing to contribute steady monthly returns for the portfolio as intended.

Now it turns out that both of these funds were Madoff feeder funds and had their capital almost exclusively with Madoff.  In other words they were essentially identical – though Rye may have been levered to Madoff.  

The descriptions given by Bramdean/Horlick are wildly different.  Did Nicola Horlick and her much vaunted investment committee know that these two funds were identical?  Or did they fail even that part of the due diligence?  There should be reports on both funds.  Nicola has told the stock exchange that the process is “systematic and disciplined” and that reports are prepared on all managers.  

If those reports did not identify that the manager was the same then Nicola’s organisation is grotesquely incompetent.  And if the reports were not prepared then Nicola has committed criminal fraud by telling the stock exchange that they were prepared and raising money based on her vaunted due diligence process.

I can’t see an alternative to incompetence or fraud – and when faced with that choice I usually pick incompetence – but hey – this is superwoman.  And who would have though that she was incompetent?

Liquidity needs of the private investments

There is a second problem here – which is the annual report clearly states:

The Company invests in this low-risk, high-liquidity fund [Defender] as a vehicle to provide short-term liquidity to fund private equity capital calls. 

The Defender moneys are now gone down the Madoff Ponzi.  It is incumbent on Bramdean Alternatives to inform the market as to how they now intend to fund private equity capital calls. 

They may have other resources – indeed they hold cash.  But a disclosure to the stock exchange is required.  

Did Nicola Horlick’s due diligence allow Bramdean Alternatives to get fleeced on a day-to-day basis by Madoff feeders?

One thing about the Rye reporting puzzles me.  Madoff never reported a down period.  A levered Madoff fund always made money until the ponzi was exposed.  But Bramdean Alternatives reports that there were periods where the fund did not cover its cost of leverage.  

This is strange… did Nicola Horlick allow her clients to be fleeced on the monthly returns by Rye or some other intermediary?  If so what does that say about her due diligence?  She could of course do due diligence on Rye…

Bronte’s view

Every day that Bramdean remains licensed (FSA register number: 410624) is a day that brings discredit to the British Capital Markets.  Removing Nicola’s licence is in my view a no-brainer.  Either fraud or incompetence is demonstrated here.

Further the reports into Rye and Defender – both of which were prepared after “systematic and disciplined” due diligence should be made public.

Failure to make those reports public brings further discredit to the British capital markets because it makes it appear as if Nicola Horlick has been able to raise money based on fraudulent statements about the nature of her due diligence processes.

If the reports do not exist then Nicola Horlick should be charged with fraud.

John Hempton

One correction...

The Rye Select Broadmarket XL fund is a three times levered version of the Rye Select fund.  Here are the stated returns of the Rye Select fund:

A three times levered version of that would produce negative returns in some months - for instance in October when the stated "return" was 0.05 percent.  

I also have a copy of the offering document for the three times levered fund.  It never mentions the name Madoff.  Perhaps - and I am speculating here - that is why Bramdean never mentioned Madoff.  



John Haskell said...

Everybody needs to read Markopoulos' letter to the SEC - 19 pages which absolutely positively disposed of every possible "innocent explanation" for Madoff's returns, exclusively prepared using information available in the public domain.

He mentions going on a fundraising trip through Paris and Geneva where "everyone said they were invested in Madoff"- I can imagine how frustrating that was to hear.

Anonymous said...

Here is a project I would love to see someone take upon themselves. It can be safely assumed, now that Madoff has been exposed, that his was not the only Ponzi scheme left out there. The only reason he was exposed is that investors everywhere are pulling money out of equities/hedge funds. He was caught because of exogenous forces. But a few people had been speculating for a decade that Madoff's fund was a ponzi scheme. So are there records out there on the web of similar speculations about other hedge funds? If so, that could make a nice story.

Savonarola said...

FSA more useless than the SEC.

It will take complaints from shareholders to get FSA to mount what would be a token investigation.

Horlick will transfer the blame to the Man entity which steered her to Madoff.

Brandean Alts will be wound up voluntarily in a year or two because of the huge discount. Or somebody like Mellon will takeover with a promise to liquidate.

Good stuff. Hope the jobsworths at FSA take a peek at your excellent blog.

Anonymous said...

Will Nicola be paying back to Bramdean Alternatives the 1.5% fees she was paid on the Madoff investments over the past year?

John Hempton said...

I have just done something which I have never done before on this blog...

I rejected a high quality anonymous post which was on topic.

To the poster I am sorry - but the post was PRECISELY my next blog post and I want to claim some credit for it myself...

If you were not anonymous I would allow you to post it...


John Haskell said...

hempton! Hand over the booty!

John Hempton said...

Will Savonarola - who posted above - contact me if possible...

No email on your contact and I would love to meet an investment banker whose favourite book is Nostromo - the only Conrad I have read set on land.

(I guess Heart of Darkness is narrated on the Thames - but is set in the Belgian Congo...)

John Hempton said...

John Haskell- can you please email me...


Anonymous said...

Usually getting paid £75,000 a year to Chair an investment company that involves about 4 meetings a year is considered money for old rope.But Brian Larcombe, Chairman of Bramdean Alternatives may find his part time job a little more time consuming over the next few months.
Bramdean Alternatives values the Fund monthly but the majority of the portfolio is carried at book cost(the private equity portfolio).Quite why monthly valuations should be produced when the majority of the portfolio is carried at cost is beyound me (oh yes, Nicola charges her fee monthly).Anyway, as Mr Larcombe was previouly at 3i he more than anyone should know that the real value of Private Equity investments made at the top of the market in summer 2007 are now worth only a fraction of their book cost.Indeed a recent FT article suggested that initial investments were trading below 50% of cost and in some cases investors were willing to PAY for their investments to be taken off their hands in order to avoid the further drawdown commitments.As such it is reasonable to suggest that the Private equity portfolio is worth about $50 to $75m less that stated.
If Mr Larcombe doesn`t think that the NAV should include such impairment perhaps the companys auditor,PwC will in March when they have to sign off the accounts.PwC know full well the danger of allowing false valuations of public companies assets.In fact given that the company no longer has the money or borrowing facilities to pay the commitments, PwC may have to consider if Bramdean Alternatives is a "Going concern" .Mr Larcombe would do well to remember that he and his fellow Directors owe a Duty of Care to shareholders not Nicola Horlick and Bramdean LLP.I would urge Mr Larcombe to show independance and terminate the Bramdean management contract.Failing that I would recommed Mr Larcombe transfer his personal assets to his wife as this companys demise maybe faster that he can say shareholder lawsuit.

Anonymous said...

Whilst grand conspiracies always make for good blogs, isn't it more likely that the different descriptions of Rye and Defender came about because Bramdean Alternatives is managed by two firms?

Rye was in the portion managed by RMF and Defender in the portion managed by Bramdean. I assume they submitted their own descriptions for the annual report. If anything, Bramdean's description is clearer and fuller than RMF's.

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