In this update, we will address two issues. First we will review some of the investment frauds that have surfaced since the Madoff scandal. Second, with the market conditions as difficult as ever, we want to clearly restate our core investment beliefs, which we have held since the inception of our firm.
In the two months since the arrest of Bernard Madoff, the orchestrator of a $50 billion Ponzi scheme, several other investment frauds have surfaced. We will begin this discussion with the same clear message that we sent after news of the Madoff affair: Heritage Investment Group has no exposure to any of these investment frauds, including Madoff, the Stanford Financial Group, Nicholas Cosmo or any of the other scandals.
Sir Allen Stanford, the CEO of Stanford Financial Group, which oversees $50 billion in assets, has been accused of an $8 billion investment scam. The Stanford Group is alleged to have sold investors $8 billion worth of non FDIC-insured “certificates of deposit” through a network of financial advisers on the basis that they would be invested in safe, highly liquid assets, but produce a far higher return than rival banks. Instead, the vast majority of the portfolio was managed by Allen Stanford and partner James Davis. Proceeds from the “CD” deposits were actually invested in high-risk real estate and private equity investments. Investigators, who have been looking into Stanford’s operations for the past year, are still trying to pin down where all the assets are located. The Stanford news came out just weeks after Nicholas Cosmo, the owner of a New York investment firm, was accused of running a $370 million Ponzi scheme. Cosmo convinced investors they would make returns as high as 80 percent a year from interest collected on short-term loans to businesses. Now, prosecutors claim that the firm has as little as $746,000 in the bank.
Both of these more recent frauds violated the same two core principles that we mentioned after the Madoff affair was made public. First, there is no free lunch. Allen Stanford and Nicholas Cosmo were claiming to be able to earn above market returns with low risk, which is simply not possible. Second, both Stanford and Cosmo were serving their clients as both advisor and custodian. As we have stated before, there is an inherent conflict of interest between these functions, and this is why our clients have always used independent custodians such as Charles Schwab, Fidelity, Pershing, and TD Ameritrade to hold their assets. These scams prove, once again, that claims of easy money are no substitute for transparency and independent oversight.
As the global equity market decline continues to test the discipline of investors, we would like to reiterate the core beliefs which have always driven our investment process:
1) Capitalism will generate wealth over time. It may not feel like it today, but we continue to believe that capitalistic forces will allow the equity markets to rebuild and provide long term growth. Capitalism has always been a dynamic, self-correcting system with the ability to respond to shocks and emerge stronger as a result. There is no reason to believe that the current crisis will change this.
2) No one has the ability to consistently outguess the markets. Market timing (attempting to sell before downturns and buy before upturns) does not work. This is not a statement of opinion; it is a fact and has been proven time and time again. This includes timing of individual stocks, sectors and asset classes.
While the financial crisis of the past year has been very difficult on all of us, it has not diminished our belief in either of these core principals. We will therefore continue to manage client portfolios in a way that is consistent with these beliefs. We will maintain our long-term exposure to the equity markets and we will not speculate on the timing of the eventual recovery. In the meantime, it is necessary to recognize that the volatility will likely continue (on both the upside and the downside) and as difficult as the situation is, patience and discipline must be observed.
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