One of my favorite scenes in the movie There’s Something About Mary is when Ted, played by Ben Stiller, picks up a hitchhiker. The hitchhiker goes on to tell Ted about his brilliant business idea inspired by the 90s workout phenomenon, 8-Minute Abs:
Hitchhiker: You heard of this thing, the 8-Minute Abs?
Ted: Yeah, sure, 8-Minute Abs. Yeah, the exercise video.
Hitchhiker: Yeah, this is going to blow that right out of the water. Listen to this: 7… Minute… Abs.
Ted: Right. Yes. OK, all right. I see where you’re going.
Hitchhiker: Think about it. You walk into a video store, you see 8-Minute Abs sittin’ there, there’s 7-Minute Abs right beside it. Which one are you gonna pick, man?
Ted: I would go for the 7.
Hitchhiker: Bingo, man, bingo. 7-Minute Abs. And we guarantee just as good a workout as the 8-minute folk.
Ted: You guarantee it? That’s – how do you do that?
Hitchhiker: If you’re not happy with the first 7 minutes, we’re gonna send you the extra minute free. You see? That’s it. That’s our motto. That’s where we’re comin’ from. That’s from “A” to “B”.
Ted: That’s right. That’s – that’s good. That’s good. Unless, of course, somebody comes up with 6-Minute Abs. Then you’re in trouble, huh?
I was reminded of the 7-Minute Abs pitch this week when I read about Andrew Caspersen, a private equity executive at PTJ Partners, who is accused of stealing $25 million from investors. The sales pitch he made to dupe a hedge fund investor out of this money is one of the oldest tricks in the book — promise something for nothing:
Four months later, Caspersen e-mailed the manager of an international hedge fund and offered him the chance to earn a temptingly high return, according to the criminal complaint. The investment, which he claimed was related to the restructuring of the Irving Place fund, “offers private equity returns (15%) but without the risk,” Caspersen said in an e-mail to another potential investor that was quoted in court documents.
What the investor didn’t know was that the account receiving the money, Irving Place III SPV LLC, was actually controlled by Caspersen and had nothing to do with the Irving Place firm. PJT didn’t authorize Caspersen to raise the funds, prosecutors said.
Investors are constantly in search of their own version of 7-Minute Abs. They want a shortcut and there will always be hucksters out there who will be more than happy to guarantee that extra minute for free.
The returns on this investment are just like that risky asset, but without all the risk!
You want stock-like returns with bond like volatility? Done!
How about triple-A rated subprime mortgage bonds with much higher yields than treasuries?
10% annual returns with no drawdowns? Sure, why not?
Maybe a bond substitute offering much higher yields?
How high would you like your Sharpe Ratio to be this year?
These pitches for higher returns without taking the commensurate risk will always sound appealing. Who wouldn’t want to earn more while taking less risk? The problem is that there’s no such thing as “without the risk.” Risk can never completely go away; it just changes form. There are always unintended consequences when trying to skirt risk in the financial markets. It may not become apparent for some time, but it exists nonetheless.
I’d say that much of the blame should go to those who are making promises they’ll never be able to fulfill, but investors aren’t innocent in all of this. They’re the ones clamoring for unrealistic investments. Shady advisors and fund firms are more than happy to fill that demand.
People are constantly looking for shortcuts. That’s why every year there are brand new fad diets and workouts that promise people an easier way to lose weight and get in shape.
There is no Holy Grail that allows investors to earn risk asset returns without taking on risk.
But that’s not going to stop people from looking for it, nor is is going to stop people from selling that dream.
The Cost of Not Paying Attention