The recent arrest of former NASDAQ chairman, Bernard Madoff, for operating an alleged $50 billion Ponzi scheme should remind us all that in the markets there are no free lunches. Reward (capital gains) comes with risk and consistent double-digit returns regardless of market performance is just not a realistic expectation for any investor.
For years high net worth investors and institutions have been pouring their money into hedge funds whose option-laden clandestine trading strategies have produced seemingly endless returns, but not so anymore. Many hedge funds are down 25% to 50% year to date and are now revealing solvency issues due to soaring redemption rates (investors pulling out of these funds in record numbers) and tightened credit. Bloomberg is reporting that Myron Scholes’ (author of the famous Black-Scholes equation for pricing options) Platinum Grove Asset Management fund may see withdrawals as high as 25% after the fund lost 29% in the first half of October alone.
Some blame fund managers, SEC regulators, and mortgage-backed securities, but what the Madoff case has revealed to me is how some investors never stop to question how these funds operate or how leveraged they are and only focus on the promise of extraordinary returns.
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