The Investor's Consigliere

Marc Dreier Profile in New York Magazine, and the Perils of Reputation

Another case study in investor seduction.  Dreier swindled some very sophisticated people.

As far as I can tell, the foundation of Dreier's (short-lived) success as a con artist, the reason he got in the door to see all those hedge funds, was his mere reputation as a high-profile attorney representing high-profile clients. 

Reputation, and its close cousin pedigree, is the largest early filter money manager selectors use when evaluating fund managers.  Simply put: for whom did you work before you started your fund?  It's probably a necessary filter, but every tool in the manager selector's toolbox has its weaknesses.

I hope to expand on this in a later post, but in the context of this one I'll note three of the weaknesses of the reputation filter:

The first is obviously that a good pedigree, in the wrong hands, can be wielded as a tool of seduction, of con artistry. 

The second is that reputations rise and fall, and the fall is often swift.  Warren Buffett famously said that it takes a lifetime to build a reputation and five minutes to ruin it.  Somebody has to be sitting at the other end of the table during the five minutes, and you don't want it to be you.

The third is that for all its importance, the reputation filter is a commodity, and so adds little value to the manager selection process.  I know where you used to work and how much your old boss loves you, but so does everyone else.  

Cialdini on Madoff

An essay on Madoff, by the master of the psychology of persuasion himself, Dr. Robert Cialdini.

Bernard Madoff Plea Statement

Via Reuters.

Bernard Madoff: Case Study of a Seducer

Two more Madoff profiles, one in New York Magazine, one in Vanity Fair.  Naturally they focus not on the technical aspects of his fraud but on how he maneuvered among and affected Society (not to be confused with "society").

Bit by bit, little details emerge about Madoff's seduction tactics, which worked remarkably well on a group of people you would have thought was not vulnerable to it.  Either he was extremely good at the art of con, or his victims were more gullible than I thought, or a little of both.  Most people concentrate on the latter, but don't discount the former. 

(What makes it even more amazing is that, unless I'm missing something, his taxable investors didn't earn all that much more investing with him than they would have in municipal bonds.  The idea that Madoff "made people rich," as the VF article in particular states, doesn't seem plausible.  Per the NY article his returns averaged 12% a year, which as I understand his trading strategy would have been taxed near the top marginal income tax rate.  For most of his NY investors that's about 50%, so their net returns after tax were not that much more than what they could have earned in NY munis.  But there's no country club for people who invest in NY munis.)

Seduction--in the non-sexual sense of persuasion based on something other than the pure merits of something--is not taught in school, and it's a highly undervalued part of investment manager selection.  It's a dark art, but I think it's ultimately amoral, not immoral.  Legitimate investment managers, especially those looking to raise money, should probably study Madoff's methods.  Unfortunately, they work. 

Not on me though . . .

 

The Continuing Danger of the Young Money Manager

One of the few consolations of the terrible last year in markets is that very soon we won't have to hear some version of the following from older money managers:

"These young hedge fund managers, some of them only started shaving yesterday.  They've never lived through a bear market like I have so what the hell do they know about investing?"

True in a sense, but be careful.  First, the veteran can lose money just as easily as the rookie. 

Second, and more perniciously, just because a young money manager has been humbled does not mean he now shares your thinking about risk.  And in a few years' time, when young hedge fund managers are back raising money for new funds, and they boldly advertise "I've learned my lesson," don't be so quick to believe them.  The game of institutional investment management (especially for family offices) is largely about the Old and the Rich entrusting their capital to the Young and the Poor.  But as every older person, no matter how wealthy, knows, the young will always be richer in the one thing that matters most--time.  It's perfectly rational for a younger person to take more financial risks because if things don't work out he can always start over.  Charlie Munger, who today preaches jeremiads against debt, was in his youth a highly leveraged real estate developer.  Even Warren Buffett borrowed money to invest when he was younger.

Stephen Greenspan: Fooled by Ponzi (and Madoff)

Stephen Greenspan is a professor of psychology and an expert on human gullibility who was nonetheless one of the victims of Bernard Madoff.  In this article from skeptic.com, a version of which also appeared in the WSJ this weekend, he describes what happened.

More on Marc Dreier

Via the NYT.

Bernard Madoff

Via Bloomberg (here too) and elsewhere.  It's not just the size of the con, but also the size and prestige of those who were conned.

Bravo to Jim Vos of Aksia LLC, Harry Markopolos, Brad Alford of Alpha Capital, James Hedges and others, for upholding the good name of investors in investors.

Update--much more here:

The New York Times:  Here and here and here and here and here.

Charles Gasparino

Reuters

The Wall Street Journal

The Financial Times

London's The Times and The Independent

The AP

 

Marc Dreier

This is an interesting story.  Commentary here from Richard Beales.

The obvious question is whether the duped hedge funds should have known they were being conned--Beales says yes.  I think it's too early to say.

Second-order question:  Should the investors in the duped hedge funds have known they were invested in funds that were so connable?

Obama's Name, and the Power of Bias

Sorry to get off-topic, but this article resonates with this American named Nadav Natan Manham.

Hang on a minute . . . maybe it's not so off-topic.  This blog is ultimately about how to evaluate people--the people who are investing your capital.  A difficult task, for many reasons.  Perhaps the most difficult reason for us to confront is the fact that we the evaluators are so deficient in many ways.  All kinds of biases and prejudices we hide from ourselves get in the way of the rational evaluation of others.

One bias is the simple similarity bias.  We like people who are like us--who look like us, talk like us, have names likes ours, etc.  I'd be willing to bet that if even the most sophisticated money manager selectors (those who spend many millions of dollars of time and effort to evaluate investors strictly on the basis of merit and expected return) were to examine their money managers, they'd find evidence of similarity bias:  the same background, same religion, same college attended, same way of speaking, whatever. 

If you don't take pains to identify and root out your own similarity bias and other biases, you're setting yourself up to be a sub-optimal people evaluator.