The Bernie Madoff fraud is embarrassing dozens of major players in the financial services industry, with some fund of funds firms at the top of the list. Now Morningstar, which maintains an index of average hedge-fund performance, seems determined to join the club.
FT: John Rekenthaler, vice-president of research at fund-tracker Morningstar, said it would this month write down the value of all Madoff-related funds to zero. However, it would not re-state its hedge fund index or remove the funds from it.
“We aim to capture the experience of the investor,” he said. “Their fund’s value went to zero in December.”
Well, yes, in a sense. But in reality, the Madoff-related funds performance has always been far less than Morningstar has reported to date, so the entire average is biased upwards. Investors in Madoff funds did not make 12% a year over the past couple of decades–they just thought they did.
Similarly, the “average” hedge fund did not perform anywhere near as well as Morningstar’s pre-October historical data will now suggest (a problem that CS/Tremont, another hedge-fund index, is in the process of remedying).
If Morningstar’s goal is to present the returns that investors thought they earned, fine. (Though it’s hard to see why this is really of any use to anyone). If its goal is to help people benchmark and analyse honest hedge funds, however, this approach is silly.
If Morningstar wants its data to represent an average of non-Ponzi-scheme hedge funds, it should strip out all Madoff-linked hedge funds and recalculate its historical returns. Yes, this will make hedge funds look like much less compelling investments, but at least that’s the truth.
See Also: Did We Say Hedge Funds Have Good Returns? Oops.