How to Predict the Unpredictable by William Poundstone

Author:William Poundstone
Language: eng
Format: epub
ISBN: 9781780744087
Publisher: Oneworld Publications

More eyebrow-raising was how steady the claimed returns were. The chart shows the value of a dollar invested in Fairfield Sentry against a dollar invested in the S&P 500 index. Fairfield Sentry was not only steadier than a stock index but steadier than US Treasury bonds.

Madoff knew all about volatility. But when he came to invent fake numbers, he fell back on the not-so-rational instincts we all share. He apparently felt a need to keep monthly returns close to the average he was pitching. Only once (January and February 2003) did he deliver two negative returns in a row.

You might look at the chart and say that returns can’t be that consistent. Then you wouldn’t have put your money with Madoff, and that would have been the right call. Fairfield Sentry’s investors, some of them the world’s most astute bankers, were hardly naïve. They understood that everyone who runs a hedge fund is claiming to walk on water, one way or another. They assumed that Madoff’s preternaturally low volatility was a feature of his winning algorithm — whatever it was.

Things started to go sour in August 2008. JPMorgan Chase redeemed a quarter of a billion dollars from Fairfield Sentry. The official story was that they’d become “concerned about lack of transparency.” Meanwhile Madoff and Fairfield Sentry were working on a new fund. It would use more leverage to achieve returns of 16 percent. Fairfield Sentry reportedly warned its investors that anyone who dared to withdraw money, and anyone so foolish as to not invest in the new fund, would be punished in the severest way possible, by being black-listed from investing in any future Madoff funds.

Madoff was arrested on December 11, 2008.

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