Tuesday, December 16, 2008

Madoff vs. Equity Market Neutral Funds

The table shows the average monthly returns, standard deviation and Sharpe Ratio for the Fairfield Sentry fund that was "invested" with Madoff and Credit Suisse/Tremont's Equity Market Neutral hedge fund index for the last 12 years. Based on this, Fairfield returned the same as other market neutral funds with about 3/4 of the volatility.

But the big problem with this analysis is it seems that Madoff related funds, at least recently, constituted up to 40% of this index. So it seems that the average market neutral fund is a lot more volatile than the index has been showing. If we assume a constant 40% share for Madoff the market neutral index returned 0.81% per month with a 1.20% standard deviation for a Sharpe Ratio of 1.55. So Madoff's returns were twice as smooth as the adjusted index. Assuming imperfect correlation between those funds the typical fund would be more volatile than that 1.2% monthly standard deviation.

Fairfield Sentry has a beta of 0.09 and an annual alpha of 5.5% relative to the reconstructed index. If you invested directly with Madoff you'd have "made" about 3% a year more than this.

Here are the total return indices for the reconstructed index and Fairfield:

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