Bernie Madoff’s theft from investors comprised both dollars—a net $18 billion—and hours—thousands upon thousands of them.
His Ponzi scheme changed how allocators vet managers, and not wholly for the better, according to 28 asset owners who gathered this summer to reimagine due diligence.
“In reaction to the Madoff fraud, the process has become a ‘box-checking exercise’: bogged down by increasingly bloated questionnaires, awash in documentation, and fixated on operational due diligence,” said Cathleen Rittereiser, whose firm Uncorrelated organized the event. “This approach persists despite little evidence that it produces better results.”
Board members and investment staff have to see efficiency as a sign of success, not sloth. But scrapping the status quo requires groundwork—or a CIO might find they’re the one getting tossed.
Three concrete steps for better due diligence emerged from the day-long discussion, which Rittereiser distilled in a report. Participants included 18 investment chiefs and 10 staffers from the Smithsonian, Rockefeller Foundation, University of Michigan, Penn State, Virginia Tech, and public pensions for Texas, Wyoming, Missouri, North Carolina, and more.
1. Reset Expectations. To build a lean and mean manager vetting machine, board members and investment staff have to see efficiency as a sign of success, not sloth. “Know thyself,” one asset owner group advised. Not every board has the ability to reset.
2. Make Allocators Investors. As one asset owner put it, “Maybe it’s time to jettison the idea that asset allocation creates pie slices, then the ball gets thrown over the wall to the manager selection team to go fill those slices, and never the twain shall meet.” Treating due diligence as an operational afterthought to portfolio construction becomes a self-fulfilling prophecy, attendees concluded.
3. Ask Anything, Not Everything. Flexibility emerged as the key quality missing from standard assessment practices. Why? Checking off boxes provides comfort, investors said. An itemized formula for fulfilling fiduciary duty has value, the reported noted, but as “a starting point in the process rather than an end in and of itself.” Additional qualitative and data-based inquiries should respond to the particulars of each manager and strategy. A history of high turnover? Dig into key man risk. Micro-cap focus? Use third-party data to assess capacity. And don’t wait for the sales pitch to pick these pursuits. Future best practices, the report projected, will include sending managers one page of “key questions” before meeting for “level-setting and prioritizing discussion topics.” In other words, can the canned pitch.
Is due diligence broken? Selection bias may have influenced this group’s resounding conclusion that it is. No one spends a day tackling a problem they don’t believe exists.
At least one asset owner knew firsthand the point behind fraud-centric due diligence, in addition to the drawbacks. The CIO of Yeshiva University—tasked with picking up the pieces for one of Madoff’s only institutional victims—joined 27 of his peers in calling for an overhaul.
According to the Federal Bureau of Prisons, Bernie Madoff completes his sentence November 14, 2139. One group of asset owners would argue that investors have already served their time, and then some.