Safety First

The Bernard Madoff saga has emphasized a central tenet of successful investment – keeping your money safe. For those of you not following the story, Mr. Madoff has been a presence on Wall Street since the 1960’s. He operated a brokerage firm and an “investment management” arm. The quotation marks around investment management qualify the term as Mr. Madoff was found to have been running a giant Ponzi scheme. Investors will be lucky to see ten cents for every dollar invested once the firm’s holdings are sold by the receiver.

Besides relief at not being one of the investors, what can one take from this latest incarnation of Charles Ponzi’s brainchild? I see a few lessons:

Putting money in a common private pool raises risk. Pooling money for investment purposes is, of course, a description of the mutual fund industry. But mutual funds are regulated by the SEC, have required disclosures and safeguards. Private pools (like hedge funds) have no SEC-mandated disclosures and they give the managers substantial control over the assets. Pooling into a common fund lessens the oversight an investor might bring when reviewing his or her account.

If it looks too good it probably is. Mr. Madoff reported consistent profits in up markets, in down markets and in sideways markets. No investment strategy works all the time in every type of market, never has never will.

Homework is very important. Some potential investors reviewed Mr. Madoff’s claims and found them dubious. For example, Mr. Madoff said he bought and sold specific options as part of his strategy. However the amount of money he was managing meant that he would have had to buy and sell options well in excess of the actual amount they traded. The Wall Street Journal cites one example where he would have had to have bought 22,000 contracts and only 400 traded. There were some early warning signals like this article from in an industry newsletter back in 2001 where other investment professionals raised issues about Madoff’s reported results http://nakedshorts.typepad.com/files/madoff.pdf. Barron’s had concerns, as well http://online.barrons.com/article/SB989019667829349012.html (subscription required).

So Harvest will continue to offer only separately managed accounts, where client money is held at an unaffiliated brokerage firm (we currently are using Charles Schwab) in the client’s name and set off from all other accounts. We will continue to accept the inevitable ups and downs the market will bestow on our investment approach and we will continue to do our own work because we believe sleeping well at night is a worthwhile investment objective.