Recessions seem to unearth a great number of financial frauds. But by then it is usually too late, as investors end up losing most if not all of their money. In this book, value investor Ken Fisher (son of Philip Fisher, whom Warren Buffett cites as someone from whom he learned a great deal about investing) describes five ways ordinary investors can protect themselves from being duped by a fraudulent money manager.
The final piece of advice from Fisher on the subject of avoiding frauds is for investors to do their own due diligence. He acknowledges that it is tempting to look for shortcuts. Many people make investment decisions by relying on friends or people in perceived positions of authority. But such people have increased the odds of getting duped by a rat. One of the reasons fraudsters target people belonging to affinity groups is that they are more likely to accept the recommendation from another member of the group and assume that the due diligence has already been done, rather than do their own.
In order to conduct due diligence, investors also need a fund that offers a decent level of transparency. For this reason, Fisher advises against investing in feeder funds or "funds of funds". Not only do these setups have a bunch of extra fees, but they also add a layer of obscurity, making the due diligence a lot more difficult.
SEC-registered firms are simpler to vet. These companies are required to disclose certain information, and are subject to random checks. However, SEC registration does not guarantee that a fund is not a fraud. The SEC staff is simply not equipped to be able to find all frauds before some investors get duped. Fisher gives the reader a rundown of the various forms investors should read and what they should be looking for.
Recessions seem to unearth a great number of financial frauds. But by then it is usually too late, as investors end up losing most if not all of their money. In this book, value investor Ken Fisher (son of Philip Fisher, whom Warren Buffett cites as someone from whom he learned a great deal about investing) describes five ways ordinary investors can protect themselves from being duped by a fraudulent money manager.
Rather than focus on the strategy of the fund, fraudsters distract you with things that don't matter. This brings us to Fisher's fourth signal to look out for, that of a fancy facade.
Specifically, Fisher advises that investors be wary of claims of exclusivity. The manager should want your money; he should not make you feel like he is doing you a favour. Turning the tables on you like this is how a fraudster protects himself from an investor who seeks too many answers.
Fraudsters will also focus attention on their entertainment connections. Just because a manager hangs a picture in his office showing him spending time on the yacht of a professional athlete you recognize does not make him a manager worthy of your investment.
Political leanings and affiliations with affinity groups (e.g. religious groups) are also exploited by fraudsters. Avoid being swayed by irrelevant items such as these.
Recessions seem to unearth a great number of financial frauds. But by then it is usually too late, as investors end up losing most if not all of their money. In this book, value investor Ken Fisher (son of Philip Fisher, whom Warren Buffett cites as someone from whom he learned a great deal about investing) describes five ways ordinary investors can protect themselves from being duped by a fraudulent money manager.
Fraudsters aren't really generating the returns they say they are, and therefore they can't come clean about their investment strategy. As a result, they use a lot of jargon in their strategy descriptions in an attempt to make the investor feel too stupid to ask questions. Investors must ignore the tendency to shy away from asking question, and only invest if they understand the strategy, and can compare the manager's historical returns to a benchmark that mimics the strategy.
A legitimate manager won't mind a potential client trying to get a better understanding of the investment strategy. That manager wants the investor's business, and is therefore willing to have someone explain the strategy very clearly, even to someone without a financial background.
But a fraudster doesn't have a strategy that he is willing to admit to publicly, so he will make the strategy sound complicated using a lot of mumbo-jumbo, or seem angry/insulted when asked for more details. For this reason, Fisher recommends that investors ask for a simpler interpretation of the investment strategy until it is clear enough for them to understand. If the manager can't do this, it's time to walk away.
Fisher describes the story of one potential investor in Madoff's fund who just couldn't get a coherent explanation of what Madoff's investment strategy entailed. Madoff couldn't, or wouldn't, and so the investor walked. Obviously, it saved him a lot of money. Fisher also gives other examples where fraudsters were vague about their strategy descriptions, for if they weren't, the public would be able to see that the historical returns being presented just weren't possible.
Recessions seem to unearth a great number of financial frauds. But by then it is usually too late, as investors end up losing most if not all of their money. In this book, value investor Ken Fisher (son of Philip Fisher, whom Warren Buffett cites as someone from whom he learned a great deal about investing) describes five ways ordinary investors can protect themselves from being duped by a fraudulent money manager.
The second sign that Fisher warns investors to watch out for is a track record of consistent and high returns. Ponzi schemes (which is the method of choice for fraudsters looking to get rich quick) can't afford down years, because this causes investors to pull out capital. When capital is pulled out of a Ponzi scheme, the scheme collapses. (Investors also pull money out of funds during recessions, which is why Ponzi schemes tend to be uncovered during recessions.)
Therefore, fraudsters literally can't afford to report down years, so their track records will always look consistent. But Fisher argues that real money managers have returns that are highly inconsistent, even the great ones. All managers have a few flop years, where they badly underperform either absolutely or relative to the market. But only the honest ones will show it; a Ponzi schemer will have no such blemish on his record.
Fisher advises that investors look at a manager's past performance and ask for the fund's benchmark. Look for some correlation between returns of the fund and those of the benchmark, and if there isn't any, be afraid! At best, the fund isn't even employing the strategy it is marketing to you, and at worst the numbers are totally made up.
Also, look for the years where the fund underperformed, and ask the manager what happened in those years and what he learned from them. Only if the explanation is reasonable and makes sense within the context of the fund's strategy should the investor proceed.
Recessions seem to unearth a great number of financial frauds. But by then it is usually too late, as investors end up losing most if not all of their money. In this book, value investor Ken Fisher (son of Philip Fisher, whom Warren Buffett cites as someone from whom he learned a great deal about investing) describes five ways ordinary investors can protect themselves from being duped by a fraudulent money manager.
In 100% of fraud scams, the money manager has custody of the investor's assets. Therefore, to avoid getting scammed, Fisher's first and most important rule is that investors ensure separation between the decision-making and the custody of the assets.
This is done by placing the assets with a large, third-party institution and setting up the account such that the manager only has rights to buy and sell on your behalf i.e. he cannot withdraw funds.
Of course, this does preclude investors from buying into hedge funds or other similar structures, where investor capital is pooled as part of the fund's structure. Furthermore, it doesn't ensure that a loss of capital cannot occur; the adviser can simply make bad decisions on your behalf. However, the chances that he can make off with your money is almost nil, as long as your custodian is beyond reproach.
