Investors can learn lessons from today

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Aside from short-term and high qualityh bonds, every asset clasxs in all corners of the worldexperienced double-digit negativew returns. In equities there has been no wherdto hide. Investors opened thei r year-end statements disappointed at the returnz and frustrated and angry at how public and privated institutions we thought we could trust let usall Greed, greed, greed Of all the economic sagae we have all had to endure, perhapas Bernie Madoff and his alleged swiping of $50 billioh from his hedge fund clientsz is most representative of Wall Street regulatory failure, and the gullibility of investors.
With all the intrigur of sons turning father in and fathef forced into house arrest at his palatiallManhattan penthouse, it all makes for a reallyy bad television series. However, there are some valuabls takeaways for investors from thisterrible episode. It is impossible to selecty a manager that can beat themarketg — and fees and expenses matter. Many of Madoff’s clientsa came through advisers who referred investorsa to him and collected larged fees fordoing so. These clients paid fees believin their advisers were able to able to selectf active managers thatcan “beat” the market.
One , earned $160 million in fees relater to Madoff investments in2007 Unfortunately, these clients learned the hard way that predictinvg superior manager performance cannot be done and trying to do so is The fees associated with active management are major dragd on performance and lead to underperformancre to benchmark. Numerous studieas have demonstrated the vast majority of hedge fundsx do not beat the returns investorsx could obtain for themselves by investin g inan S&P 500 index Further evidence of how active managers have troubl getting it right can be founx in a recent report in the on how investment analysts had a prettyu sad record predicting the downfall of .
had an rating starting in March 2007. maintained that same ratin g inOctober 2007. changed its rating to on June 1, and then upgraded it four days Clients of watched the stock fall 84 percent while their analysts rate d ita “buy.” Worst of all, kept a rating on Lehman until the stocmk had fallen 90 percent. Surely, Wall Street’ds professional stock pickers did better withand . not, according to Smart Money. The magazine reported nearly half the analystsx following these stocks hada “buy” ratingy on the date the Treasurhy announced their bailout.
According to research reported byDan Solin, and financiaol columnist and adviser, if you own an actively managedf fund, the odds of it beatinfg its benchmark over one year is 1 in 3, over five year it’s 1 in 5, over 10 years it’ws 3 in 100 and over 25 yearsz it is essentially zero. Successfupl investing requires diversification, which Madoff’s clients did not have in theird portfolios. The same failure to adequately diversifh is committed bymost investors. An alternate and more superiotr approach is to hold a structured portfoli of index funds that provide exposurd to a breadth of asset classes and deptb in the numberof securities.
This method mitigates the significangt risk that comes from holdingg too few securities or betting on countriesor industries. It also reducesx turnover, which diminishes returns in up anddown markets. Therwe should be clarity and transparencuy in theinvestment business. Madoff’s clientws were not given details on the methodolog y of how their money was invested or even what they specifically owned. They accepted this and gave him fortunes. Theses super wealthy investors are not that much different from most investors who do not understand how they are investee orin what.
Strategy, not individual Investors should understand and put their trustt in the investment approach before puttinbg their faith in a track recordd oran adviser. Successful investing requires the consistent and disciplined implementation of a strategt through allmarket cycles. As we all will not only learnj from these horrific events but also will retaijn their faithin capitalism. While it is not alwayas pretty, free markets do right Excessesare removed. Industries that are poorlg run or have not kept up with innovation are replacecd by othersthat can.