What Wall Street Fraud Means for ETFs

The impact of Wall Street’s alleged “pyramid scheme” of $50 billion is slowly unveiling, and could even impact some ETFs. ETFs could join a long list of those hurt by the fraud, including pensions, charities, hedge funds and large banking institutions.

Joe Bel Bruno and Jane Wardell for the Associated Press report that the alleged victims who sunk cash into Wall Street money manager Bernard Madoff’s investment pool include real estate magnate Mortimer Zuckerman, the foundation of Nobel laureate Elie Wiesel, and a charity of movie director Steven Spielberg.

Among the banking institutions involved are Britain’s HSBC Holdings PLC (HBC), Royal Bank of Scotland Group PLC (RBS) and Man Group PLC (MNGPF.PK), Spain’s Grupo Santander SA, France’s BNP Paribas and Japan’s Nomura Holdings (NMR). The pyramid scheme has robbed some of finance’s biggest players of $2 billion, with banks taking the biggest hit.

France’s BNP Paribas said Sunday its maximum potential loss was about $468 million; The Royal Bank of Scotland is out $600 million with hedge fund exposure; Banco Santander of Spain is exposed $23 million plus and Japan’s Nomura is out $303 million, according to CNN Money. HSBC is the largest victim at $1 billion.

A Ponzi, or pyramid scheme, is an investment fraud in which high profits are promised to investors from fictitious sources. Early investors are paid off with funds raised from later ones. Madoff was a former chairman of the Nasdaq exchange and was arrested last Thursday on a single securities charge for heading the $50 billion scheme.

The Global Hedge Fund Index, designed to represent the overall composition of the global hedge fund universe, is down 22.7% year-to-date. It normally has a two-day lag, so it remains to be seen how the latest developments influence the index.

Hedge funds are largely unregulated, and they’re mysterious entities only open to a select few investors. They’ve seen heavy redemptions this year, and this could be the straw that breaks the camel’s back. Even decently performing hedge funds, in fact, are said to have been seeing such heavy withdrawals that they’ve halted redemptions.

Those who invest in them are placing a lot of trust in the companies that run them. But will people be wondering now whether they can be trusted after all? We won’t know all the ramifications for awhile, but it may not be pretty.

• iShares MSCI Spain Index (EWP): down 40.7% year-to-date; Santander 18.1%

• iShares MSCI France Index (EWQ): down 44.4% year-to-date; BNP Paribas 7%

Comments

[sbenard:]

I'm not convinced that I see sufficient correlation between your explanation and the two ETFs you've highlighted. Spain and France? That strikes me as a rather weak correlation!

2008 Dec 16 01:25 PM

[huangthomas:]

Where are the correlations? HSBC and Nomura banks had couple of billions in Madoff's pockets too. What do you say about Great Britain and Japan?

2008 Dec 16 01:37 PM

[raytayzmd:]

....?????...I don't see your argument...certainly, Madoff's scam will impact a lot of investors and cause some perturbations as victims are forced to realign their portfolios...but how that will affect EFT's in any special way isn't obvious...and I don't really see how the graphs relate to your article -- for the past year pretty much any stock ETF looks about the same...

2008 Dec 18 02:39 PM