It’s not easy to figure out if one is good or bad at running money.


Last week came the news of the acquittal of a fund manager who lost a lot of money for his clients by investing in Bernie Madoff’s fund. The judge in the case justified the action on the grounds the manager “did not violate his duty of management” and his belief in Madoff’s products was “legitimate”. (See this FT article for story and background.) Recall that Madoff had manufactured a very strong and stable performance record over a period of decades.

How can you make sure a string of numbers associated to any investment fund or product is real – even if not fraudulent? The judge in the mentioned acquittal speaks of duty and legitimacy, but the number of duped investors was enormous, including many in the professional field of asset management (mostly through “feeder funds” or “funds-of-funds”). An interesting side note to the saga is that while Bernie Madoff and most of his team have been found guilty of fraud, amazingly not one of the managers who channeled clients’ money to them has received the same treatment.

When you look at performance you always have to think about the possibility the figures are purely the result of random events. Nassim Taleb in Fooled by Randomness did a wonderful job in talking about the role of the unpredictable in our lives (the book is highly recommended). And for this reason, almost over anything else, all performance figures need to be treated very carefully: we often don’t have enough time to figure out if they show real skill or pure luck.

Going beyond the imponderable, here are some reasons why so many investors and professionals all over the world may have gotten involved with Madoff:

  1. Contrary to most legal disclaimers investors look at past figures as proof the track record (good or bad) will continue in the future, despite strong evidence to the contrary;
  2. Often investors want to believe a good story because the idea of easy money is very intoxicating, forgetting the maxim “if it sounds too good to be true, it probably is”;
  3. There is money to be made by channeling client funds in various investment vehicles, an important conflict of interest;
  4. Personal bonds count for a lot: if you know the managers you will tend to trust more than question them;
  5. Due diligence is a widely used expression but with very different meanings, depending on who you work with;
  6. Peer pressure: your friends are all invested in something and they are making a lot of money; you must invest as well;
  7. How can such a friendly open face belong to a mega-thief? (See photo.)

It’s really tough to do, I know, but the only way one should ever invest in an actively managed investment strategy is only after having discussed with the decision-makers their investment process. It takes time and effort; but it’s your money in the end.

Photo source: