FTSE 100
Dow Jones

Tuesday, 7 April 2009

My other investment scheme is a Ponzi

I have never been a fan of the asset management, wealth management, whatever you want to call it industry. The premise of the investment manager is as follows:

"You Mr. Investor have a lot of money, and I, though I have less money than you, am actually better at investing than you, even though that might seem hard to believe because, as I said, I have so much less than you."

"Nevertheless, because you are so busy and have so little time to read the news wires and crunch numbers, I will do it for you, but instead of being paid according to the time and resources I dedicate to the task, you can pay me according to the value of funds that I manage for you. That way I get to be more profitable simply by adding new clients with no extra work at making investment decisions."

"But I don't expect you to just pay me for the service that I offer. No, in order to incentivise me to actually succeed in my endeavours, you will agree to pay me according to the return on your investments, say 20% of any return over a stated benchmark."

"But since you will appreciate that as well as being dynamic and creative, I also have a cautious side, I will ask you to measure my performance not so much against the actual return you make, but against the performance of the market in general and also against the performance of other fund managers. In practice this means that you pay extra for my skill and judgement not because I am good at my job, but because I am not as dumb as the next guy".

So who falls for this crap? Well, quite a lot of people actually because Andrew Cuomo, the New York attorney-general, on Monday filed civil fraud charges against the hedge fund manager Ezra Merkin, alleging he channelled more than $2.4bn to Bernard Madoff’s Ponzi scheme in exchange for lucrative fees.

The move is the second action in two weeks against one of the feeder funds that sent billions of dollars to Mr Madoff, who pleaded guilty to one of history’s biggest investment frauds. Mr Merkin, a leading figure in the New York charity community and former chairman of financing company GMAC, of steering money from charities, universities and non-profit organisations to Mr Madoff and being paid about $470m in fees for his three funds.

Hang on a minute there. $470m in fees for $2,400m in investment? Merkin passed over $2,400m of client money and Madoff paid 20% of that money back as commission, and Merkin didn't bat an eyelid? He really thought Madoff was so good at investing that he could give the market a 20% head start and still earn enough to pay management and performance fees to Merkin and Madoff? What do you think?

So what of Ms Horlick, who as you may remember won our Financial Crime of the Year Award in 2008, not for investing with Bernie Madoff, but for crying foul when Madoff was accused of fraud. Investment managers are supposed to know what they are investing in. That after all is why they are paid (see above). But if Merkin was paid 20% commissions by Madoff, how much was Ms Horlick paid for delivering her clients' capital?


Grenville said...

Hmmm. There are plenty of examples of ways you can brow-beat the industry and these are particularly bad ones: you are right, but you're only half right.....

People forget that one of the main functions of a Private Bank, for example, is to actually do whatever it is the client wants to be done. i.e. to enact whatever it is that they want to do with their money.

One of the skills in Private Banking - other than to be truly trusted (which you can't buy for love or money) - is to know what the best way might be, given the circumstances, risks etc, and given what the client tells you and how the client thinks etc, because there are billions of different products out there, some of which might be quite specific, and useful in the right circumstances, and just the thing.

Unfortunately the world is not perfect, and mistakes do happen (the AIG Enhanced Fund springs to mind) either through incompetence or fraud, as the examples you give, or just through plain bad luck or the fundamental unpredictability of financial markets. So the business of "running people's money properly" is's not actually as easy as you might think.

For example, who says that you have to use active managers? So if you decide not to use active management, how do you propose actually to do it? Etcetera.

You may not believe it, but there are legions of people in the fund management industry who have spent entire working lifetimes genuinely trying to do the very best they possibly can for their clients.

Like you?

Alex said...

"You may not believe it, but there are legions of people in the fund management industry who have spent entire working lifetimes genuinely trying to do the very best they possibly can for their clients."

Client advisory work is very different from fund management. I work in the former where the interests of the client are paramount, and the client typically pays only for success. Retainers and per diems are rare. I know plenty of private bankers who think they have a measure of trust from their clients, but the trust is more typically with the institution and may wealthy indiviuals will change advisor from time to time because they simply don't want to use the same advisors all the time.

Fund managers are by nature working for the fund and not the individual customers of the fund.
There is an inherent compromise between the collective benefit of the fund and the benefit of a particular customer.

That said, I fuind the fee levels in investment management extraordinarily high for the level of risk and the knowledge and skill required, particularly when the bench mark for success is a relative measure. As I pointed out at the end of last year, in 2008 my socks outperformed every major index and most fund managers as an investment vehicle.

Anonymous said...

Hi Alex, as a regular reader I marvel at how you find the time to enlighten us whilst performing your many other tasks, so it causes me no concern when the odd keyboard typo slips in. However I am left reeling with laughter at your 'outperforming socks'. Typo or not my wife swears a pair of mine could give yours a run for their money!

Alex said...


That is not a slip. My socks are black and long. Any cash stored in them on 1 January 2008 would have retained its value on 31 December 2008, and so they outperformed most fund managers in 2008, particularly equity funds, and every major equity index, although their fee basis is eminently reasonable.

I should add that they are not currently regulated by the FSA.

Anonymous said...

The Bank of England printing money through quantitative easing will, we think, set a floor under the corporate bond market and underpin real estate prices. Our upgrades indicate positive real estate returns in 2010, with REIT shares leading the recovery by 6-12 months.

From a Guardian article on Property Company share prices. Oh dear.

Alex said...


You want a translation of that?

"In the long term oproperty has a value as as useful asset in terms of accommodation. OK, it lose value in a bad economy, but not by nearly as much as the the value of money which is being driven down by quantitative easing. If the relative value of money declines by more than the value of property, it will look as though the value of property is stablising or increasing."

Anonymous said...

Cheers Alex, must change my Oh dear to Oh f**k. It's worse than I thought! Have a good weekend dude