Giving me the Creeps


Ronald Niebuhr’s ‘Serenity Prayer’ talks of having the serenity to accept the things I cannot change, and granting the courage to change what I can. It is with this in mind, that I write this article.

Ponzi schemes always succeed for a while. The inability to verify the real value of underlying assets is not the only reason for this. People genuinely want to believe in them. This is evident not just in bull market conditions, but is even more noticeable in bear markets when traditional asset classes are not performing strongly. The guy promising the steady 10% a year returns can always attract enough people who want to believe the story. If you repeat something often enough, you may even begin to believe it.

This abundance of new Ponzi’s is evident in the number of avoid (read: Avoid like the Plague) asset analyses that MBMG Asset Management has produced recently on investments built around utterly illiquid and unquantifiable underlying assets such as student accommodation, litigation funding, receivables, forestry, traded life/endowment policies, even care homes and fancy tree oil funds. The assets themselves may have value, but the investment method of many schemes distorts this over time so that a valuation gap develops. When you mark your fund pricing to model, instead of marking-to-market, an investor can be pretty sure that the number on their latest valuation is not accurate. Marked-to-model funds quote a performance, with the idea being that they retain surplus returns in good times to fill shortfalls in inflows in bad times. As long as new investment keeps coming in, they can keep paying out at the quoted price.

However, it is what happens when new investment dries up that you see the truly creepy effects of marked-to-model pricing. Investors who try to withdraw when the actual performance falls below quoted value may find that they are either prevented from doing so by a suspension of redemptions or are paid a much lower amount virtue of a discretionary reduction. This is known as a Market Value Adjustment. In a sustained period of negative performance, where the fund’s underlying asset has become increasingly divorced from the marked-to-model price, such suspensions or write-downs tend to become inevitable. This valuation gap means that it is not a question of ‘if’, but a question of ‘when’ significant investor losses will occur. This is the creeping neo-Ponzi.

Central Banks have done the same with capital markets. The valuations rely upon a model of Central Bank support and not genuine economic activities. Traded global assets have become neo-Ponzis too. As artificially priced as some of the aforementioned funds above, the question to be asking is, “What will trigger the collapse of Mark-to-Fantasy pricing?” Will it be an inflationary or a deflationary bust? When will it happen, and what should investors do?

I accept that Ponzi schemes, from Ivan Kreuger at Swedish Match in the 1930s, to Bernie Madoff and the neo-Pons of the twenty-first century, will always be around. They’ll always succeed for a while. But it never lasts. Caveat Emptor!

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Graham Macdonald on [email protected]