All that glitters…

Just read the story about the allegations against Bernie Madoff.  $50B- wow. Stunning not only in the magnitude, but scope and time span that this seems to have occurred within. Some immediate thoughts that come to my mind regarding this:

  • It has got to hard to lose $50B (assuming that this number is accurate) without considerable help… I can only wonder what happened with firm compliance? Kinda makes me wonder if compliance was based in Nigeria… What about audits? Who were his investors and how often did they review due diligence?
  • It REALLY is hard to make money over the long term in the market. When you consider the caliber of investors experiencing significant losses this year, it reinforces how challenging the markets really are. Ask most VCs (which I consider essentially value investors), and they will tell you that their hit rates are low but returns on those high. And most returns in that industry are concentrated in relatively few firms. Even standard equity investors best hit rates are maybe 50%+. Making money in a long term systematic fashion is improbable in a reasonably efficient market. The alternatives? Cheat or create a structural advantage.
  • What else is lying around out there? Is this the first “cockroach” among many?
  • The investment industry is rife with poor business practices and this is an example of how it can play out. Given that the nature of returns are episodic and performance unmangeable (remember, “past perfomance is no guarantee of future performance…”), there is little advantage in scales of economy when you could go out of business next week. If you scale up to reduce your cost structure, then what happens if the unpredictable occurs? Also, there are considerable fixed costs in highly professional business practices- and in a business that has considerable performance risk, it makes perfect sense to keep fixed costs to a minimum. It must be terribly painful to pay for a professional audit that proves you were trounced by your benchmark.
  • There is nothing new under the sun. This financial business is so attractive that there will likely always be a new version of a “shortcut.” The lure of wealth appears to be the ultimate narcotic.

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