Tuesday, December 16, 2008

A Parable That's Actually a True Story

From a newsletter...

In a former life, your California editor called himself a hedge fund manager. The year was 1995 and he and two partners were overseeing a modest investment management business.

One fine day, one of the partners got the idea that the firm should expand its marketing efforts by hiring an expensive, New-York-based marketing firm. This partner also argued that your California editor should facilitate the marketing effort by conducting all the face-to-face meetings with prospective clients

A short time later, he found himself on a cross-country flight to New York to attend a variety of meetings that the expensive marketing firm had arranged. First stop: Rye, New York, to meet with Tremont Group Holdings, a firm that placed money with selected hedge funds

After about 30 minutes of back-and-forth, the Tremont folks said something like, "Well, this sounds very interesting, Eric. You have a very unique approach. But we've got a couple of concerns."

"Okay, let's hear 'em," your editor politely replied.

"Well, because your firm is relatively small, it does not possess the kind of risk control infrastructure that we would like to see. Furthermore, since you don't really have extensive checks and balances within the portfolio management structure itself, the strategy relies too heavily upon the instincts of one individual. So we'd need to see more assets under management, a longer track record and better risk-controls in place before we'd consider an investment."

"Okay, thanks for the advice."

Yes, you know the rest: Tremont lost $3BILLION with Madoff...but that's not the parable.

Some sophisticated investors are so sophisticated that they begin to believe their own marketing materials; they begin to believe that placing $5 million with a three-man investment shop that provides complete and continuous transparency is riskier than placing $3.3 billion with a large investment shop that dresses its books and records in a burqa.

Book-and-cover, folks. There are lots of professional-service firms that dress up pretty.

And there are lots that don't. Results may be identical, but 'pretty' sells better.

For no good reason.

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