Bernie Madoff

As you read about Risk:Return, I asked you to also read Harry Markopolis’ article on Bernie Madoff. When Bernie Madoff’s funds were sold, prospects were told that his historic fund returns were ~12% annually with minimal risk (only 7 out of 174 months had a negative return during the entire charade – and none exceeded -.56%). Various articles were written expressing skepticism that anyone could achieve this level of returns (here is one from 2001: Ocrant, Michael (May 2001), "Madoff tops charts; skeptics ask how" , http://nakedshorts.typepad.com/files/madoff.pdf), but for a variety of reasons there was no follow up. To put some context on the returns, here are some comparative annual returns: S&P 500 (US) EAFE (Global) US Treasury Bonds World Bonds US Treasury Bills (<1 yr) Annual Return 11.8% 10.7% 7.5% 5.8% 2.2% Std. Deviation 16.7% 20.5% 10.3% 8.7% 2.1% Assume that this is 2002, both the US and European markets have been down for 3 consecutive years (but they had been up for the prior 9 consecutive years – which no one remembers when returns are negative) and your broker has suggested a Madoff fund (lucky you – not everyone got this opportunity). The fund’s return for the last year was 5.6% vs. -22% for the S&P 500 and -32% for Euro Stoxx 600 (the primary index for European companies). Moreover, while the fund has ‘modest’ returns, it never seems to lose money. Using Risk and Return as a framework, how would you respond?