Join with 10,000+ savvy investors that get Michael's insights, newsletter & podcast episodes.

as seen on:

Bernard Madoff in Barrons Circa 2001

Here is a 2001 Barrons article that 2008 apologists for Bernard Madoff clients probably wanted to forget about:

Monday, May 7, 2001

Don’t Ask, Don’t Tell Bernie Madoff is so secretive, he even asks investors to keep mum


Bernie Madoff might as well hang that sign on his secretive hedge-fund empire. Even adoring investors can’t explain his enviably steady gains.

Two years ago, at a hedge-fund conference in New York, attendees were asked to name some of their favorite and most-respected hedge-fund managers. Neither George Soros nor Julian Robertson merited a single mention. But one manager received lavish praise: Bernard Madoff.

Folks on Wall Street know Bernie Madoff well. His brokerage firm, Madoff Securities, helped kick-start the Nasdaq Stock Market in the early 1970s and is now one of the top three market makers in Nasdaq stocks. Madoff Securities is also the third-largest firm matching buyers and sellers of New York Stock Exchange-listed securities. Charles Schwab, Fidelity Investments and a slew of discount brokerages all send trades through Madoff.

Some folks on Wall Street think there’s more to how Madoff (above) generates his enviable stream of investment returns than meets the eye. Madoff calls these claims “ridiculous.” But what few on the Street know is that Bernie Madoff also manages $6 billion-to-$7 billion for wealthy individuals. That’s enough to rank Madoff’s operation among the world’s three largest hedge funds, according to a May 2001 report in MAR Hedge, a trade publication.

What’s more, these private accounts, have produced compound average annual returns of 15% for more than a decade. Remarkably, some of the larger, billion-dollar Madoff-run funds have never had a down year.

When Barron’s asked Madoff Friday how he accomplishes this, he said, “It’s a proprietary strategy. I can’t go into it in great detail.”

Nor were the firms that market Madoff’s funds forthcoming when contacted earlier. “It’s a private fund. And so our inclination has been not to discuss its returns,” says Jeffrey Tucker, partner and co-founder of Fairfield Greenwich, a New York City-based hedge-fund marketer. “Why Barron’s would have any interest in this fund I don’t know.” One of Fairfield Greenwich’s most sought-after funds is Fairfield Sentry Limited. Managed by Bernie Madoff, Fairfield Sentry has assets of $3.3 billion.

A Madoff hedge-fund offering memorandums describes his strategy this way: “Typically, a position will consist of the ownership of 30-35 S&P 100 stocks, most correlated to that index, the sale of out-of-the- money calls on the index and the purchase of out-of-the-money puts on the index. The sale of the calls is designed to increase the rate of return, while allowing upward movement of the stock portfolio to the strike price of the calls. The puts, funded in large part by the sale of the calls, limit the portfolio’s downside.”

Among options traders, that’s known as the “split-strike conversion” strategy. In layman’s terms, it means Madoff invests primarily in the largest stocks in the S&P 100 index — names like General Electric, Intel and Coca-Cola. At the same time, he buys and sells options against those stocks. For example, Madoff might purchase shares of GE and sell a call option on a comparable number of shares — that is, an option to buy the shares at a fixed price at a future date. At the same time, he would buy a put option on the stock, which gives him the right to sell shares at a fixed price at a future date.

The strategy, in effect, creates a boundary on a stock, limiting its upside while at the same time protecting against a sharp decline in the share price. When done correctly, this so-called market-neutral strategy produces positive returns no matter which way the market goes.

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 skeptical 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. Likewise, three option strategists at major investment banks told Barron’s they couldn’t understand how Madoff churns out such numbers. Adds a former Madoff investor: “Anybody who’s a seasoned hedge- fund investor knows the split-strike conversion is not the whole story. To take it at face value is a bit nave.”

Madoff dismisses such skepticism. “Whoever tried to reverse-engineer, he didn’t do a good job. If he did, these numbers would not be unusual.” Curiously, he charges no fees for his money-management services. Nor does he take a cut of the 1.5% fees marketers like Fairfield Greenwich charge investors each year. Why not? “We’re perfectly happy to just earn commissions on the trades,” he says.

Perhaps so. But consider the sheer scope of the money Madoff would appear to be leaving on the table. A typical hedge fund charges 1% of assets annually, plus 20% of profits. On a $6 billion fund generating 15% annual returns, that adds up to $240 million a year.

The lessons of Long-Term Capital Management’s collapse are that investors need, or should want, transparency in their money manager’s investment strategy. But Madoff’s investors rave about his performance — even though they don’t understand how he does it. “Even knowledgeable people can’t really tell you what he’s doing,” one very satisfied investor told Barron’s. “People who have all the trade confirmations and statements still can’t define it very well. The only thing I know is that he’s often in cash” when volatility levels get extreme. This investor declined to be quoted by name. Why? Because Madoff politely requests that his investors not reveal that he runs their money.

“What Madoff told us was, ‘If you invest with me, you must never tell anyone that you’re invested with me. It’s no one’s business what goes on here,'” says an investment manager who took over a pool of assets that included an investment in a Madoff fund. “When he couldn’t explain how they were up or down in a particular month,” he added, “I pulled the money out.”

For investors who aren’t put off by such secrecy, it should be noted that Fairfield and Kingate Management both market funds managed by Madoff, as does Tremont Advisers , a publicly traded hedge-fund advisory firm.

Posted in Economics, Holy Grails
7 comments on “Bernard Madoff in Barrons Circa 2001
  1. The brightest person was the investment manager who pulled his funds out when Madoff could not explain his returns-i just wonder how many other scam artists exist out there?

    In South Africa we’ve had numerous insurance scams that resulted in some beneficiaries committing suicide around 5-10 years ago after being ripped off by “household name companies”.
    The government cracked down on these very strongly.

    Ultimately the individual investor should be responsible for his/her own investments

  2. Aside from the obvious failures of regulators and independent auditors of Madoff’s operation, there is one very simple issue that shocked me the most when I first heard the news;

    The custodian of client funds was his own securities firm; not a independent depository outside of his control.

    So, he ran a fund via the money mnagement firm he owned and the money he managed was held by the securities firm he owned. And that securities firm cleared the trades for the fund (or not). You’d think he’d instead want to avoid even the appearance of such a conflict and have an independent bank or broker custody the funds, account for assets, and print the statements. That is, unless it’s a fraud…

    Lesson for Madoff investors; require that your money manager manage your account held at a third party custodian, not the very firm the manager owns!

  3. SS says:

    “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.
    When Barron’s ran that scenario by Madoff, he dismissed it as “ridiculous.””

    LOL, he certainly was right about it being ridiculous.
    Subsidy? Not even !!

    “Curiously, he charges no fees for his money-management services. Nor does he take a cut of the 1.5% fees marketers like Fairfield Greenwich charge investors each year. Why not? “We’re perfectly happy to just earn commissions on the trades,” he says.”

    Biggest red flag possible !!!

  4. sloane says:

    Arvelund’s 2001 article really drives home the idea that Madoff was simply supplying a demand: dreamily consistent returns to those who were content to stick their heads in the sand.

    Dr. Tantillo did a short blog post on Madoff when this story first hit, explaining how Madoff’s success can be attributed to knowing his Target Market (not that he condones his behavior…).

    “He knew not to promise sophisticated people unsophisticated (read “extravagant”) returns. In other words, he knew people would walk away if he promised them the sun and moon, but 10 to 15% seemed about right. He was also reportedly very selective —not everyone could become a client— and that kind of exclusivity, if exerted by a credible party (like Madoff seemed to be), can have real power.”

    I wonder if investors will be more or less vulnerable to these sorts of schemes (believing what they want to believe), given the current economic client. Recent news might suggest that people will be more cautious, but a more desperate mindset could actually tip things further in this same direction.

  5. Tim says:

    Best line from the article. Speaking about Madoff’s consistent 15% returns:

    begin quote-

    When Barron’s asked Madoff Friday how he accomplishes this, he said, “It’s a proprietary strategy. I can’t go into it in great detail.”

    -end quote

    he’ll be going into great detail about his proprietary strategy in front of a judge soon enough.

  6. David says:

    Funny thing is no one writing about Madoff for the past ten years — even the skeptics — seems to have ever looked at Madoff’s annual financials from their accounting firm, Friehling and Horowitz.

    The reports, which are public, aren’t easy to get a hold of, but aren’t impossible, either. I got the most recent one from the SEC, and wrote up a bit about it:

    If anyone wants a copy of the full report, just contact me through my blog, and I can email it to you.

    When the full Madoff story unfolds, in will be interesting to see what sort of culpability the accountants had in the whole sordid affair.

Covel Books & Film
Massive Performance

Trend following performance numbers.

Trend Trading Systems

Pricing for trend following systems. 1000s of clients across 70+ countries.

Free Market Wizard Video

Get your free trader legend video.

Live Trend Following

Michael Covel's live events.

Trend Following Podcast

Michael Covel's podcast. 3M+ listens; 400+ episodes: iTunes & Android.


Online Payments


Regular guy makes TREND FOLLOWING fortune. His free video lesson: WATCH IT NOW.