by Jeff Feldman.
Bernie and A-Rod have a lot in common. First of all, they both cheated. Second, several people suspected they were cheating. Third, both were at the top of their profession, seen as virtually peerless. Now there is no question that they are responsible for their actions and should face the consequences. But aren’t Bernie’s investors and A-Rod’s employers and fans equally culpable? Didn’t they see what they wanted to see? Bernie provided what were ostensibly above-market, low risk, returns. A-Rod hit home runs at an unprecedented rate. They both gave the market exactly what it wanted.
So let the market be warned. We have to be vigilant and when, as the saying goes, it looks too good to be true, there is a very good chance it is to good to be true. As an investor, I have a simple rule. If someone is offering consistent returns and constantly taking in new money, I assume it’s a Ponzi scheme. One can never be sure, and I may miss a great opportunity one day, but I’ve been in the business 42 years and it hasn’t happened yet.
Plus, Bernie would not explain his trading strategy and that is always a red flag.
Ironically, regarding strategy, baseball used to be a game of strategy and statistics. The home run was not the centerpiece of the game. A true baseball fan enjoyed a 1-0 game decided by a suicide squeeze just as much as a 10-9 game with 7 home runs. But over the past 20 years, as with other sports , baseball became a power game. We got caught up in the home run onslaught of what steroid enhanced players like Mark McGwire and Sammy Sosa. The video game generation does not have the attention span required for the traditional slow-moving baseball game.
Baseball has been around for more than 100 years; ballpark dimensions provide fairly consistent numbers of home runs. The game didn’t need home runs to attract fans, until recently. As the home run became more important, and since baseball could not move in the fences without destroying the integrity of the game, the incentives for hitters to take steroids blossomed. And with the hitters juiced, some pitchers felt the need to keep up. Team owners, and management, understood the value of the home run and so had an incentive to look the other way. The point is, it would be virtually impossible to change the nature of baseball from a strategy based game, to a power based game, without changing the dimensions, or the equipment. So, you had to change the players.
There is an analogy in investing. It has been extremely difficult for fund managers to produce consistent, above market, returns over a long period of time. Three quarters of
of fund managers do not outperform their chosen benchmark in any given year. Bill Miller at Legg Mason beat the S&P 500 15 years in a row (making him a Superman) then lost almost 45% in 2008. And if one invested with Miller in 1998, currently that position is underwater by 10%. So now comes Bernie Madoff to a game of strategy and statistics and he says he will not be a home run hitter but rather will consistently hit doubles and triples (and he will never strike out). Investing has been around longer than baseball and nobody has been able to overcome the odds without cheating. So with Bernie, as with A-Rod, we should have known.
The more troubling aspect of the Madoff business is the sense of entitlement expressed by his investors. They believed that the wealthy play on a different playing field with different rules. They could have their cake (higher returns) and eat it, too (no risk). I don’t know if the $50 billion number is an accurate measure of the money Bernie took, but assume for the moment it is. If that money had been invested in a basket of opportunities in medical technologies and environmentally friendly innovations, the potential returns would have been a multiple of the $50 billion and the downside would unlikely not be as bad as the total loss his investors are facing.
So let the market be warned. We have to be vigilant and when, as the saying goes, it looks too good to be true, there is a very good chance it is to good to be true. As an investor, I have a simple rule. If someone is offering consistent returns and constantly taking in new money, I assume it’s a Ponzi scheme. One can never be sure, and I may miss a great opportunity one day, but I’ve been in the business 42 years and it hasn’t happened yet.
Plus, Bernie would not explain his trading strategy and that is always a red flag.
Ironically, regarding strategy, baseball used to be a game of strategy and statistics. The home run was not the centerpiece of the game. A true baseball fan enjoyed a 1-0 game decided by a suicide squeeze just as much as a 10-9 game with 7 home runs. But over the past 20 years, as with other sports , baseball became a power game. We got caught up in the home run onslaught of what steroid enhanced players like Mark McGwire and Sammy Sosa. The video game generation does not have the attention span required for the traditional slow-moving baseball game.
Baseball has been around for more than 100 years; ballpark dimensions provide fairly consistent numbers of home runs. The game didn’t need home runs to attract fans, until recently. As the home run became more important, and since baseball could not move in the fences without destroying the integrity of the game, the incentives for hitters to take steroids blossomed. And with the hitters juiced, some pitchers felt the need to keep up. Team owners, and management, understood the value of the home run and so had an incentive to look the other way. The point is, it would be virtually impossible to change the nature of baseball from a strategy based game, to a power based game, without changing the dimensions, or the equipment. So, you had to change the players.
There is an analogy in investing. It has been extremely difficult for fund managers to produce consistent, above market, returns over a long period of time. Three quarters of
of fund managers do not outperform their chosen benchmark in any given year. Bill Miller at Legg Mason beat the S&P 500 15 years in a row (making him a Superman) then lost almost 45% in 2008. And if one invested with Miller in 1998, currently that position is underwater by 10%. So now comes Bernie Madoff to a game of strategy and statistics and he says he will not be a home run hitter but rather will consistently hit doubles and triples (and he will never strike out). Investing has been around longer than baseball and nobody has been able to overcome the odds without cheating. So with Bernie, as with A-Rod, we should have known.
The more troubling aspect of the Madoff business is the sense of entitlement expressed by his investors. They believed that the wealthy play on a different playing field with different rules. They could have their cake (higher returns) and eat it, too (no risk). I don’t know if the $50 billion number is an accurate measure of the money Bernie took, but assume for the moment it is. If that money had been invested in a basket of opportunities in medical technologies and environmentally friendly innovations, the potential returns would have been a multiple of the $50 billion and the downside would unlikely not be as bad as the total loss his investors are facing.
Madoff Style Investments Don't Cure Diseases
In addition, the successful technologies would improve standard of living for the rest of us. It is very dangerous for the wealthy to believe that they can strategically avoid risk and make money with an options trading strategy that benefits nobody but them. Even if it were possible, the eventual consequences of such a strategy could be dire. We need to invest in a sustainable, and growing, economy.
Back to Basics
Our nation, and particularly the wealthy, has to get back to basics.
Investment analysis is about balancing risk and reward -- not eliminating risk.
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