If you invested in Bernard Madoff’s ponzi scheme through a feeder fund like Fairfield Greenwich that took 20% of the fictious gains, you’d have nothing left after just 15 years. The feeder fund’s share of the made-up gains would have eaten through all of your principal.
Here’s how it works.
Let’s say you meet one of Fairfield Greenwich founder Walter Noel’s charming son in laws on a ski slope somewhere in Switzerland. He shows you the amazing Madoff returns that convince you to invest $10 million with Fairfield Greenwich’s Sentry Fund. Prepare to be cleaned out.
- Right off the bat the fund takes 1% of the investment for itself. Your assets: $9.9 million.
- Year one. On the first anniversary of your investment, the fund reports you’ve made $1.485 million, a fifteen per cent gain. Of course, those gains are completely fictious. Nonetheless, it takes 20% of the made-up $1.485 million gain. That’s leaves you with just over $9.6 million of real assets but phony assets listed as $11.1million.
- Year two. The next year, the fund tells you that you made another 15% on your $11.1 million, for a phony gain of $1,710,000. The fund takes $342,000. Just as your made up gains keep growing through the magic of Ponzi compounding, the fees taken by the Fairfield Greenwich keep going up. The crucial difference: your gains are made up, while the fund’s fees are real. You keep getting poorer while they keep getting richer. After just two years, the fund has made almost $742,000 and you’ve lost exactly that much. Real assets: $9,258,000. Phony assets: $12,468,000.
- Year three. Ponzi returns are $1,870,000. Fund takes $374,000. That leaves you with real assets of just $8,884,000. See how this works? After just three years you’ve lost over 11% of your original investment–and all that money is in the hands of the feeder fund.
- Years four through 15. Each year, the fund takes more and more of your money because the 20% keeps getting charged against a fictiously higher number. After about fifteen years of this, the feeder fund will have taken every dime you’ve invested and you will have been completely wiped out. Your assets in Year 15: $0.
Actually, you would be wiped out even more quickly, because every year the feeder fund would take an additional 1% of the total amount you have invested with them. And, of course, they’re taking it off the phony, growing number not the real, diminishing number. So each year that 1% would produce a larger number, allowing the fund to keep digging away at your principal investment.
What this means is that we should probably be a bit…what’s the polite word here?…sceptical when the people who ran these feeder funds tell us that they were “victims” of Madoff too. After all, they had real gains taken directly from the pocket of investors.