Take boutique New Zealand investment business Ross Asset Management (RAM), which has gone into receivership owing clients hundreds of millions of dollars.
New Zealand’s Serious Fraud Office has launched an investigation into RAM, whose Wellington offices were raided by regulators in November following complaints from investors that they were unable to get their money out.
RAM was headed by financial advisor David Ross and worked out of a small office with just two support staff.
Some 900 individual investors were attracted by the group’s reported returns, which receivers PriceWaterhouseCoopers estimated at 25 per cent a year since the year 2000.
Yet while Ross claimed to be holding investments worth nearly half a billion dollars on behalf of clients, PWC found records of just $10 million. The whereabouts of the rest is unclear. While not making any direct claims of fraud, both PWC and the Financial Markets Authority have said RAM had “characteristics of a Ponzi scheme”.
Under such a scheme, a manager reports false and inflated returns and pays out these false returns to investors from contributions made by new investors. The problem with such schemes is managers have to keep reporting high returns, even if they are false, to attract new money in order to meet withdrawals.
Certainly Ross appeared to have convinced a sufficient number of people to keep money coming in. One client was quoted saying that Ross “seemed to know everything about what was going on in the market” and had a “fantastic” track record.1
This supposed track record was based on a strong bias towards small, high-risk mining stocks, very concentrated portfolios, the lack of any audit record and the reliance on a single individual with no back-up expertise.
The investment performance of RAM’s funds was reported without any independent verification or audit. There was no independent custodian. As well, receivers found no record of broker transaction statements, no record of portfolio valuations, no broker contract notes and no registry records.
Just to put RAM’s losses into perspective, assuming investors in the RAM funds lose everything, the total loss in proportion to the size of the New Zealand economy will be about twice that of the Bernie Madoff Ponzi fraud in the US.
While the upshot of all this is a depressing one – hundreds of people look to have lost their life savings – it nevertheless provides a number of key lessons for investors everywhere.
Firstly, one should be sceptical about any scheme that promises consistently positive returns – well above the market – year after year. Not even Warren Buffett has managed to beat the US S&P-500 these past three years.2
Risk and return are related. So it is possible to outperform the market, but not without accepting more risk. Besides, if you were consistently able to generate 25-30% returns, why would you share your insights with anyone else? You wouldn’t need to.
Secondly, any investment based on a few stocks or a couple of sectors – like RAM claimed to be doing – means taking on unnecessary risk. That’s a gamble, not an investment. By contrast, diversification allows you to capture broad market forces while reducing the uncompensated risk associated with individual securities or sectors.
Thirdly, you should never under-take an investment without first receiving independent advice from a fiduciary paid by you to do due diligence on the opportunity and to tailor a strategy to your needs, not based on what they have to sell. In the case of RAM, Ross was both providing the advice and investing the money. And he was doing so without an independent custodian. That should have rung alarm bells somewhere.
Finally, it is not a good idea to make an investment based on the supposed ability of an individual to forecast the future. Aside from the fact that there is no evidence that anyone can do so with any consistency, it means the success of your investment is a highly-correlated to an individual’s expertise or integrity.
A better idea is to insist on a clear investment philosophy, a transparent investment process, an approach based on evidence rather than forecasts or intuition and a consistent application with proper safeguards for investors.
No-one can guarantee a positive return every year. But you can be sure that a structured approach based on the principles of modern finance and the efficacy of capital markets will add value with higher reliability and confidence than one based on instinct and prophecy.