Now that Bernie Madoff has been exposed, everyone claims to have known about Wall Street’s biggest open secret, that his too-good-to-be-true returns were in fact too good to be true.
Here’s a Barron’s piece on Madoff from 2001 titled Don’t Ask Don’t Tell:
Using this split-strike conversion strategy, Fairfield Sentry Limited has had only four down months since inception in 1989. In 1990, Fairfield Sentry was up 27%. In the ensuing decade, it returned no less than 11% in any year, and sometimes as high as 18%. Last year, Fairfield Sentry returned 11.55% and so far in 2001, the fund is up 3.52%.
Those returns have been so consistent that some on the Street have begun speculating that Madoff’s market-making operation subsidizes and smooths his hedge-fund returns.
How might Madoff Securities do this? Access to such a huge capital base could allow Madoff to make much larger bets — with very little risk — than it could otherwise. It would work like this: Madoff Securities stands in the middle of a tremendous river of orders, which means that its traders have advance knowledge, if only by a few seconds, of what big customers are buying and selling. By hopping on the bandwagon, the market maker could effectively lock in profits. In such a case, throwing a little cash back to the hedge funds would be no big deal.
When Barron’s ran that scenario by Madoff, he dismissed it as “ridiculous.”
Still, some on Wall Street remain sceptical about how Madoff achieves such stunning double-digit returns using options alone. The recent MAR Hedge report, for example, cited more than a dozen hedge fund professionals, including current and former Madoff traders, who questioned why no one had been able to duplicate Madoff’s returns using this strategy. Read >