One in five hedge fund managers found to be misrepresenting facts

One in five hedge fund managers misrepresents their fund or its performance to investors during formal due diligence investigations, research from New York University's Stern School of Business suggests.

The research is likely to be a further blow to the reputation of a battered industry, which has faced increasing demands for transparency from investors in the wake of the credit crisis.

Using confidential data taken from 444 due diligence reports commissioned by investors between 2003 and 2008, academics at Stern analysed the extent to which hedge fund managers' representations about their funds differed from reality.

Managers most commonly misrepresented the amount of money they had entrusted to their funds, their performance and their regulatory and legal histories, according to the research.

One manager told investigators that his assets under management were $300m (£190m) higher than they actually were.

Another fund - according to Professor Stephen Brown, one of the report's co-authors - was found to have lied about the unblemished legal records of its partners.

The founders of the fund in question, it transpired, both had criminal records, having once stolen a Chinese junk.

The paper identified "noted verification problems" - characterised as "misrepresentations or inconsistencies" - in 42 per cent of due diligence reports.

In some instances the discrepancies represented managers' unfamiliarity with their internal procedures and legal processes, but in 21 per cent of cases "the manager verbally stated incorrect information".

Covering funds with up to $8bn in assets under management and managers with an average of 19 years of experience in the industry, the data captures some of the most prominent hedge funds in operation.

Due diligence reports are usually kept confidential and can cost as much as $100,000 to commission. They were made available to Stern on the basis that funds' individual details be kept confidential.

As well as analysing the occurrence of falsehoods, Stern's academics also sought to gauge its severity and its implications. Researchers looked specifically at instances where funds had been in some form of regulatory or legal trouble in the past and found that nearly one in six managers either underplayed or denied the existence of such problems.