Tuesday, January 13, 2009

More Thoughts on Madoff

The Madoff affair has stirred up a buzz within the financial press and among financial advisors. Some advisors had client assets with Madoff and were caught in the fallout. Most advisors had no exposure and of these some are now congratulating themselves in the press for having the prescience to dodge the bullet. I find the extent of back-patting going on to be interesting and wonder how many of us advisors were lucky rather than insightful.

I remember a very smart, experienced analyst telling me once that even the best analysis can’t protect against fraud perpetuated by a determined person, because finding fraud requires detective work rather than analysis. Given that, what can be done going forward to protect assets from a fraud like this? Just as a good diet and exercise help us stay healthy there are basic investment rules that we can follow to help keep our portfolio sound. But just as diet and exercise alone can’t prevent every disease, the basic rules won’t always keep you out of the crazy pitfalls of the markets.

Transparency – It’s helpful to have securities that are priced daily and even if it is a fund to have regular reporting so the securities held by the fund are known and valued. This policy rules out using hedge funds that aren’t required by law to report their holdings, and until hedge funds are transparent we don’t believe in investing in them.

Show Me the Money – Having an independent custodian that hold the assets and is independent of the money manager introduces a good check-and-balance. Madoff’s investors sent their money to Madoff. Even large mutual funds use outside custodians (such as State Street Bank) to custody assets and don’t hold the money themselves. Separation of the money manager and the custodian is a good thing.

Diversification – Diversifying among managers, styles and asset classes is still the best and no-brainer way to reduce if not avoid risk. Keep in mind that the biggest losers in the Madoff fraud are those who had all their assets with the Madoff firm.

If it Smells Like a Free Lunch… – I’m not convinced that all Madoff investors were being greedy. My guess is that some felt that the returns of 8% - 10% a year that Madoff was targeting indicated a conservative strategy. Not being market professionals, they didn’t know that target requires a swing-for-the-fences mentality. Think about it – there’s no way 8% - 10% can be achieved consistently in down markets by using low-risk strategies.

Veena Kutler

No comments:

Post a Comment