[Ok, ok . . . I've been slow on my long-promised post about out-years risk, but I started writing it last night and the post got unruly. Back to the drawing board on that one . . .]
In the meantime, I've got another quick thought about this whole Madoff mess: I'm amazed – but unsurprised – by how international the roster of victims has been. (Harry Markopolis, the man who tried to alert the SEC, suspected that half to three quarters of Madoff's capital came from overseas). As you read through the list, you can almost imagine Ricardo Montalban or Catherine Deneuve reading off the foreign names with crisp and precise diction (while heavily accenting the American ones: Ferh-feeeld Ghreenesh Ehdvisors . . . Tree-Mon Groope . . .) It's a far-flung group that now shares a common shame.
And that got me thinking about how we, as investors, do diligence. I mean, information is the raw material of investing, right? I'm not talking a Gordon Gekko/Bud Fox sort of information ("Blue Horseshoe loves Anacot Steel.") What I'm talking about is knowledge. Do you have a view? Is your opinion the product of a dialectic? How was the tension in your thinking resolved? What data tipped the scales in favor of one route, but not another? After all, we're just intelligent switches and network nodes, gathering and processing information.
And if information is our sustenance, how often do we outrun our supply lines? I've been thinking a lot about the epistemology of investing lately: how do we know what we know? Is it harder to triangulate information when investing across the country? Across the world? How frequently do we not speak the same language (literally or metaphorically) as the people with the insights? How frequently do we not even know who those people might be?
And fund of funds have it even worse. At least the primary investors are buying assets with (hopefully) some intrinsic value or growth potential. FOFs make investments in the people who buy those assets, placing at center stage the most pernicious irritant in all of finance: the Principal-Agent Problem. Don't get me wrong: I'm not kicking any of the cats who lost money. I'm sure they're all smart, well-intentioned people who somehow wandered beyond the frontiers of their expertise or suspended their disbelief. It reminds me of the exchange in Leo DiCaprio's Magnum Opus Catch Me If You Can:
Frank Abagnale, Sr.: You know why the Yankees always win, Frank?
Frank Abagnale, Jr.: 'Cause they have Mickey Mantle?
Frank Abagnale, Sr.: No, it's 'cause the other teams can't stop staring at those damn pinstripes.
Now I don't want to sound provincial. Investing is a global discipline and we need to seek out the best risk-adjusted returns wherever they might be. My fear is that we've systemically underestimated the amount of risk in going increasingly far afield.
In people businesses, it's actually really valuable to see people firsthand, to look them in the eye, to know where and how they live, to bump into them at the grocery store, to interact with them closely in hopes of building a sense of mutual obligation. That's the genesis of trust. And in finance – just as in a democracy – someone must be trusted. And, indeed, trust is always at a premium, it's just that today trust is also in extremely short supply.