The Bernard Madoff Ponzi scheme rightfully attracts a lot of attention in the media, partially because the victims are generally extremely rich and successful. The media tends to portray the victims as "sophisticated" investors, which makes the Madoff scheme appear to be that much more incredible. However, the "pitch" that Bernie Madoff made to potential investors had two essential and deep flaws in it that should have been obvious to "sophisticated" investors. And therein lies a lesson that is valuable to all investors.
Bernard Madoff's pitch to potential investors had two key elements in it:
However these were presented, both of these ideas are red flags to any investor with any personal experience or understanding.
All investors should understand that you lose sometimes and that there is no such thing as a guaranteed system.
A core concept of investing in equities is that you will lose money.
Equity investors who cannot embrace this idea should simply not purchase stocks -- at all!
It is simply not possible to be correct 100% of the time. Most professional investors are satisfied with being right about 60% of the time. A "correct" strategy that works 60% of the time is sufficient to generate tremendous wealth in the market.
In fact, the key aspect to being a successful investor is not taking action when you are "right." The most important aspect to success is taking action when you are wrong -- even if -- especially if -- it means losing money on a position.
Yet Madoff claimed to never lose money, at least on a monthly basis.
The most incredible part of this claim was the assertion that his strategy worked in up and down markets. Since markets change direction so quickly, it would seem impossible to have any type of position -- particularly a large one -- that could be positioned in such a way to capture gains no matter which why the market moves.
Yet this is precisely what Madoff claimed to be able to do for many years running.
Anyone who challenged these claims of always positive returns was rebuffed with a claim that he had a "proprietary" system -- which, of course could not be revealed.
More incredible to us, however, than the claimed returns, was Madoff's claim that he had discovered a system that always worked.
In up markets or down markets, his system could exploit positive returns.
This idea also flies in the face of sheer logic.
One of the central elements of successful investing, in our view, is realizing that there is no such thing as a guaranteed system.
If there were, ALL of the money would already be flowing toward the possessor of such a system.
Furthermore, if someone did discover a "sure thing" system, why reveal it or take investors? Why take a "fee" for employing it? Over time, you could simply take the principal of all other investors. Why generate returns for someone else?
Just imagine if you truly had a "sure thing system." Wouldn't you simply borrow money to increase your capital, instead of taking a fee to invest other people's money? Using leverage would be a much more profitable approach than managing investments.
Since all of the money does not flow to a single person or entity in the market, it is logical to assume that there is no "sure thing" system out there. Any other belief is misguided.
The very concept that there is a "sure thing system" in the market should be a red flag for any investor. It simply is not possible.
Yet this basic idea -- at the core of any approach to investing -- was accepted by the so-called "sophisticated" clientele of Bernie Madoff.
The most highlighted aspect of Bernard Madoff's pitch has been the "exclusivity" factor.
Almost all of the victims that have come forward have told a similar story. After initial rejection, they were eventually accepted as investors.
Could it be that Madoff used this exclusionary "cycle" to filter out any investor who might have been sophisticated enough to ignore Madoff's claims?
After all, we have all seen the constant e-mail and commercial bombardments of people selling "sophisticated" system approaches to investing. Many have a distinctly unsophisticated air about their messages; particularly the late-night/early morning infomercial pitches that run alongside TV shows that explain how to buy a house worth hundreds of thousands for just a $400 tax-lien.
While many tend to view this type of "sure thing pitch" as clearly aimed at unsophisticated clients, the Madoff clientele "bought" a similar type of pitch. The only real difference is that it was sold in a highly targeted manner, at country clubs and charity balls, and not on late-night infomercials.
Bernard Madoff's fraudulent investment scheme is likely to be the hallmark event of these times in future history books. It will likely be analyzed in numerous ways.
The lesson for all investors, today, however, is very simple and one which all investors in equities should embrace from day one:
To believe otherwise is extremely unsophisticated.
The real conclusion from this is that Madoff's investors, contrary to the way they are portrayed in most of the media coverage, were not sophisticated when it comes to the investment world.
There were as unsophisticated as they come.
They just had a lot of money -- or rather -- used to have a lot of money.--Robert V. Green, Senior Investment Strategist