In March 2009, Bernard Madoff pleaded guilty to 11 felonies and admitted his wealth management business was simply a Ponzi scheme that lost billions of dollars of his investors’ money. No one ever walked onto the 17th floor of the office building where Bernie Madoff conducted his fraudulent operations producing fake portfolio statements. And by no one, we mean none of the professional investors, institutional consultants, independent advisors, fund of funds managers, etc. who placed billions of dollars under his care for their clients. In hindsight, it seems preposterous that the advisors would fail so miserably in doing the most basic homework. Even the Securities and Exchange Commission failed to perform proper due diligence.
We insist on doing our own homework. During our early years, we retained outside institutional consultants to provide manager due diligence, but found their work product generic, somewhat superficial, and loaded with numbers and charts, but lacking in judgment and common sense.
Today we conduct a rigorous due diligence process on every manager who is approved for use by our advisors. The steps involve personal visits with the managers to evaluate their character, examine their office processes, investigate their outside auditing firm, assess their business practices, and acquire a “gut” feeling for their commitment, competence, and prospects. Certainly we look at all the performance numbers and peer group comparison, but as with Madoff, numbers alone are not enough.
We have turned down multiple Madoff-like opportunities over the years for a variety of reasons that could all be categorized as “educated suspicion.” Something just doesn’t add up. The proposed manager has some aspect of performance or process or philosophy that doesn’t calculate. A simple example with Bernie Madoff was that he did not charge management fees, but was supposedly compensated through commissions generated via his broker-dealer. It is a direct conflict of interest to have a firm that is in charge of managing the money and at the same time serving as custodian accounting for the money. Lacking an independent appraisal, there was no way to know if the money was really there…which, in this case, it wasn’t.
During the time when the real estate market was booming and managers were packaging Collateralized Debt Obligations that offered investors the hope for double-digit returns from the leveraged mortgages, we visited a manager touting certain success. One visit to his office was enough for us to eliminate him from consideration. The office had a billiard table in the center of its space where several “traders” were “relaxing” in the middle of an arduous day. We were pleased to miss the opportunity to invest, because the company’s fund offerings eventually lost more than three-quarters of their value.
Several times we rejected managers on the basis of their personal behavior or excessive demands. For example, we refused to invest with one well-known hedge fund manager during his first fund offering when we couldn’t tolerate a five year lock-up. The hedge-fund followed relative value arbitrage, borrowing large sums to generate profits from small anomalies in the fixed-income markets. After years of steady performance, the fund began a losing streak that led to the collapse of the firm.
Similarly, we rejected investing with a large hedge fund based on their demands for a 3% management fee, 30% of profits, and a three year lock-up. Added questions about personnel disputes within the firm were enough for us to stay clear. Quality firms are marked by quality people operating in an amiable work environment with enthusiasm and excitement about practicing their professional skills, not contentious people focused on personal gain. As a point of note, this fund has subsequently experienced significant legal and regulatory troubles.
We also avoid investing with managers practicing unnecessarily complex strategies. Our due diligence team has extensive experience and advanced diagnostic skills and can decipher almost any investment strategy. But when we sense excessive complexity, especially if we have the impression that it is intended to obfuscate rather than add value, we pass on the opportunity.
And we don’t like firms that continually roll out multiple strategies and funds with the intent of growing assets rather than generating solid returns. These firms invent different strategies skewed to richly reward the managers if they work, but to leave the investors holding the bag if they don’t. In essence, the firms are diversifying their risk of a failed strategy by adopting multiple different funds, demonstrating a lack of conviction in a single strategy. If they don’t have conviction, we certainly don’t have conviction.
In essence, there are thousands of managers and funds available to investors, many of which can offer real value. There is no need to invest with those that fail a thorough due diligence process, and we refuse to place our clients’ money at risk with any manager who hasn’t met all of our due diligence tests.
The case studies described herein are intended to illustrate Manchester Capital Management’s approach to developing personalized solutions to our clients’ unique investment management problems. These examples should not be considered to be recommendations for any particular client and are not intended to demonstrate a pattern of success or guarantee positive performance. Because our recommendations are individually tailored based on each client’s individual needs, there is no guarantee that our approach to managing any client’s account will share some or all of the characteristics as the situations depicted.
Nothing contained on this website constitutes investment, legal, tax or other advice and is not to be relied on in making an investment or other decision.
3657 Main Street
(P.O. Box 416)
Manchester, VT 05254
New York, New York
410 Park Avenue, Suite 1610
New York, NY 10022
1157 Coast Village Road
Montecito, CA 93108
123 East Main Street, Suite 1A
Charlottesville, VA 22902