Market Review: January 2009 Commentary

One of the most amazing stories of a pretty amazing 2008 came right at the end. It was the revelation that a USD50b Ponzi (or pyramid) scheme had been operating in the US for possibly decades. In addition, it attracted several big names to invest large portions of their net wealth and, even more unbelievably, several major institutions had significant sums invested in it.

Ponzi schemes, for the uninitiated, are simply investment funds that pay out the early investors from the investments of later investors. Hence, it pays to get in early to a Ponzi scheme and then get out. These schemes are required to subscribe to Newtonian physics – eventually they must fall down to Earth, as there will not be enough new investors to keep paying out current investors. They are also illegal, of course.

Their success lies in the ability of a promoter to keep attracting new funds into it. Take a trustworthy former NASDAQ chairman named Bernard Madhoff, who was very well known amongst the US financial community, the Jewish community, as well as at elite golf clubs in New York and Florida, and you have someone that “high net worth individuals” will happily invest their money with. But for a scheme to go for so long and attract the interest of institutions, you need to put up some strong numbers. This, Bernie Madhoff did exceptionally well. His results were so consistently strong that investors felt he almost had some magic attached to him.

I see a lot of fund managers in my job and receive lots of return series from them, for a range of asset classes and hedge funds. One of the most interesting ones I received last year was the following (from an international manager I will not name):