Monday, December 15, 2008


A lot of people in the blogosphere are talking about how they knew that Madoff's scheme was obviously a scam. I got the returns data from the Fairfield Sentry fund which was invested in Madoff from Nomura's 3x Leveraged Product factsheet:

Does this look obviously like a scam? The returns are nowhere near as smooth as many media reports claim. One interesting feature is a decline in returns over time which could be related to increased difficulty in paying distributions and redemptions but hedge funds in general have seen declining returns. There is also an apparent reduction in the variance of returns.

The average monthly return from October 1996 to the present was 0.749% with a monthly standard deviation of 0.622% and a Sharpe Ratio of 2.506. This is a slightly higher return and a slightly lower variance than the TIAA Real Estate Fund. The reason that the latter fund is so smooth is that it receives a constant stream of rent payments and only slowly revalues its properties. But for a strategy depending on the stock market this does seem suspiciously smooth. The Credit Suisse Tremont Hedge Fund Index returned 0.728% with standard deviation of 2.205% in the same period. CREF's Bond Market Fund returned 0.463% with s.d. of 1.073%. Man-AHL returned 1.631% with a standard deviation of 5.257%. So this fund gave similar returns to the average hedge fund with less than bond market levels of volatility or just under half the returns of a managed futures fund with about an eighth of the volatility. No wonder Nomura's investors wanted to leverage into it! The returns have correlations of 0.23 to the MSCI World Index, 0.12 to the Credit Suisse/Tremont index and zero to the bond market. With these kinds of stats a Markowitz style portfolio analysis would tell you to put all your money in the fund as some clients seem to have done.

This total return index chart looks more obviously scamlike:

Yet another lesson to not put too much money with any one manager of anything but simple asset class exposures (that are well audited).


Anonymous said...

ha! They knew...riiiighhhtt. I just love how when someone/something turns out to not be what/who it says it is, people like to say they knew all along.

I think what happened here is what happens every day on a macro level: people go by reputation instead of checking it out for themselves and truly understanding what's 'under the hood', so to speak.

It all just puts me that much more in the 'passively managed' corner.

mOOm said...

My lesson from this and everything else that has happened is I need to be more and more diversified. And I think that includes being diversified across more and less active management.