Securities: Analysing fund performance to discover fraud

On the face of it, it's simple: take the declared investment strategy, plug it into a model and see if what the fund manager tells you is happening is what the model says is happening.

According to Dr. Stanley Feldman, Chairman of Axiom Valuation, "AIRAS would have discovered the Madoff fraud early on, because the reported returns were not consistent with Madoff's reported investment strategies."

But in that sentence is the crux of the problem: Madoff kept his investment strategies (not that there were many of those) secret, claiming that he had "proprietary techniques." His reason for that was simple: no complex modelling was required to know that his scheme was not capable of producing the declared results and so the only way of keeping the illusion going was to pretend that there was a scheme, that it was a serious secret and that the returns were there. And that pattern of lies was needed both to prevent people asking for their money back and to keep bringing in new victims.

Axiom Valuation has released its "Alternative Investment Return Authentication Service (AIRAS), a product for investors that analytically tests whether the managers of hedge funds and private equity funds are properly reporting Net Asset Values (NAV's) and associated returns of their investments."

There is little doubt that such a tool can be worth its weight in bent fund managers but it is only as good as the information fed in.

That will be the product's challenge.