Investing with Bernie

I'd like to see a new movie made as a parody of the dumb rich, "Investing with Bernie". The twist from the hilarious movie, "Weekend at Bernie's" would be that zombies would be the dumb rich being led along to invest with Bernie Madoff who proceeds to steal all their money as they foolishly give it to him on and on for years.

The Funds of Funds and private banks would be Bernie's facilitators, funneling their dumb clients' money to Bernie while at the Hamptons and golf clubs and other parties and charity balls in tuxedos partying with him.

Location of Large Amounts of Madoff Money Revealed ...

I'd guess about 1/3 of the Madoff money is in the coffers of the governments. Think about this: 10% returns for 10 years is 100%. So Madoff investors had taxable income over that period of 100% of their "investment". All would be short term gains. At a rough 33% tax rate, the amount to be withdrawn to pay taxes is 33% of the total invested. So that 1/3 is residing in the government treasuries.

The funds of funds and advisors had to be paid. They got 1% per year and 10% of "gains", so that's 2% total per year. Over ten years, that's 20% of the total. So now we have accounted for 53% of the total.

Bernie probably gave away 25% to his charities and expenses which were critical sources of new money for his scam. That gets us to 78%. Let's presume Bernie lost about 12% in the flowing money through his firm to support it as his cover.

The last 10% is probably in Bernie's offshore accounts where he'll flee before going to prison.

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Here's a quote from today's Wall Street Journal online edition from David Swensen, the famous and very successful manager of Yale's endowment.

"Fund of funds are a cancer on the institutional-investor world. They facilitate the flow of ignorant capital. If an investor can't make an intelligent decision about picking managers, how can he make an intelligent decision about picking a fund-of-funds manager who will be selecting hedge funds? There's also more fees on top of existing fees. And the best managers don't want fund-of-fund money because it is unreliable. You need to be in the top 10% of hedge funds to succeed. In a fund of funds, you will likely be excluded from the best managers. [Mr.] Madoff also relied enormously on these intermediaries. He wouldn't have had nearly as much resources were it not for fund of funds."

I'd modify the first two sentences to "Funds of funds are a cancer in the investor world. They facilitate the flow of capital of the stupid rich."

What does Swensen say to do ?

"You can divide institutional investors into two camps: those who can hire high-quality, active-management investors and those who can't. If you are going to invest in alternatives, you should be all in, and do it the way Yale does it -- with 20 to 25 investment professionals who devote their careers to looking for investment opportunities. Or you belong at the other end, with a portfolio exclusively in index funds with low fees. If you're not going to put together a team that can make high-quality decisions, your best alternative is passive investing. With a casual attempt to beat the market, you're going to fail."

How does this apply to individuals ? Easy. Either find a good broker for work with you to invest and do the hard work, or adopt a diversified, Krypto Fund style, or a bit of both.

Does Swensen recommend changes now ? No.

"I don't think it makes sense for an institutional investor with as long an investment horizon as Yale's to structure a portfolio to perform well in a period of financial crisis. That would require moving away from equity-oriented investments that have served institutions with long time horizons well."

How does this apply to individuals ? Simple. Pay attention to time horizon. Any needs in near term should be funded with safe investments, like top rated annuities or bond index funds like the Vanguard Total Bond Market Fund, which was up in 2008. Longer term needs continue to be funded with diversified equity investments. The allocations depend on your age and realistic retirement plans.

According to Swensen, what looks good now ?

"Distressed securities are one of the most interesting opportunities for institutional investors. But returns won't come right away because the credit markets are fundamentally broken. TIPS [Treasury-Inflation Protected Securities] are pretty attractively priced. They promise reasonable returns, and protection against inflation is really important. We may not see it in the next year or two, but the government's massive fiscal stimulus can't help but produce massive inflationary pressures. Stocks also look a lot more attractive than they have for a long time. We prefer higher-quality companies with low leverage."

Hmmm ... Mrs. B has the high quality stocks with low leverage covered. Obama Fund is going for distressed securities - the stocks, at least. And Krypto Fund has the TIPs covered. Close enough. By the way, the Krypto Fund time horizon runs from about 10 to 30 years from now.

Word of the Day

"Deliquesce" - verb, intransitive [$10]; an oldie from the card file
Deliquesce means to become liquid, melt.
Sentence: The monies of the dumb rich were fed to Bernie and quickly deliquesced in his mouth like sugar candy.

Deliquesce is a word I saw reading Florence King's books. She wrote a superb column for National Review for many years and several fine books, too. She combines humor and erudition brilliantly.