The Insider

The Insider – The best return and worst investment I ever made

If you have read the press over the last month, you’ll likely be familiar with scandal surrounding The Edge betting syndicate, what is rumoured to be one of Australia’s largest Ponzi schemes.

Daily Telegraph coverage

You would be forgiven for thinking only the stupid or greedy have invested, but this is really a story about how our familiarity and trust in friends can override our ability to assess risk.

An adviser with first hand experience of the syndicate and shared their experience below:

The Insider

A number of years ago I was introduced to a betting syndicate run by a Bill, who was a friend of a friend of my friend John. This was during the GFC and John was relating that he was relieved that he only had a small amount in the markets and that he had put some money into a betting syndicate run by a guy named Bill, a good friend of someone John had grown up with.

My mate John had invested in it for a year or so, and he’d done exceptionally well, earning approximately 60%, and Bill emailed out a spreadsheet of the bets he placed every Saturday morning before the races and an update every Monday after the races, recording how much they had made or lost.

Naturally I was interested, I work in financial services and I’m always keeping my eye out for something with a good return. This was also exciting and different, and if nothing else, it made a good talking point. I asked if I could throw some fun money in.

This was my overall view in terms of how returns were achieved:

  • Bill, with a business partner, had developed a ratings system on what was a good price for the horses in each race
  • As a result, he then placed bets on a number of horses in each race, putting the odds in his favour
  • I wasn’t sure at this stage but I thought he was also arbitraging returns across different markets
  • He didn’t use all the funds each week which limit losses in some way

These are the things I found re-assuring in my 5 minute analysis:

  • Bill was a close friend of an old schoolmate of John
  • I had the view Bill was less likely to rip off friends than strangers and was a psychologist (so was going to be ethical in nature)
  • John’s friend who introduced him to Bill also worked in financial services
  • The betting sheet was sent out prior to the races each Saturday and sent again every Monday with the results and profit made
  • I had heard that a group of investors in another small syndicate in Brisbane/Queensland used the betting sheets to bet independently as well as investing via the syndicate
  • Rumour was his previous bookmaker no longer wanted to deal with him and he had just moved to another bookmaker having been banned from betting with a number of others
  • It was my view that his system on betting on a number of horses in one race limited the likelihood of losing all the money in one quarter
  • Bill didn’t really take much as a fee. I think it worked out at about 10% of any growth we achieved. This fed into my view of a club for friends.

My only real concern at this stage was whether he would be able to continue to achieve such good returns.

The first red flagsRed Flag

The returns did seem to be coming in, I received the betting sheet before the races and the sheet afterwards with the bets placed and each week I was informed on whether we made or lost money. I recall briefly looking at the sheets a couple of times and trying to deconstruct the returns but I couldn’t really make sense of it, the odds they were getting seemed to be considerably better than I could achieve on sites like Betfair and they were placing each way bets on some races which weren’t being indicated on their initial Saturday betting sheets. Having said that, I have never considered myself a betting man and there are obviously ways of getting better odds than Betfair out there.

The punters club in Queensland could obviously clearly understand the sheets as there had also been talk of no longer issuing the betting sheets, there was talk that they were being circulated outside of the club and this was impacting on our potential returns. I emailed a few questions over to Bill as to how to understand them, but never heard back. I presumed he was too busy. Time passed and I withdrew the majority of my initial stake and returns and left a small holding in there. My initial questions aside, I had no time to deconstruct this further, it was a small amount of money anyway.

A shoemaker’s son always goes barefoot

A couple of years passed and my remaining stake had grown with returns of 50-60% in each year. It was at this point that I needed to look at this again. I pride myself on how I research suitable investments for my clients and I’m often told by investment managers that I do a lot more due diligence than other researchers, yet here I was with an investment in a betting syndicate that I didn’t really know much about. I decided that although this was play money, it was time to either understand what I was investing in or withdraw the money.

Adviser instinct says something smells

Around this same time, I had heard that the size of the pool had now increased to $20 Million from around $2 Million a couple of years ago. This didn’t make sense to me as a tenfold increase in the pool should mean returns were harder to achieve, it also indicated that this was now more than just friends investing. However, there’s a lot of bravado when it comes to investing and people always talk up how much is invested.

Either way, I thought it was time that I practice what I preach and I looked into the betting sheets again and I recall one particular race not making sense. Of the say 6 horses in the race, they had bet on 4 horses. The size of the bets and odds indicated that they would not be able to make a profit if any of the horses came in. You may think with hindsight that it was obvious this was a scam, but I was firmly of the belief that Bill was running a straight up betting syndicate. My view was he was probably leveraging his returns in some way, I clearly just didn’t understand this betting sheet, or this was a scam. Regardless, I didn’t want to be invested unless Bill was willing to explain how he was getting these returns and he obviously wasn’t going to give this away, so I withdrew. I expressed my concerns to John and encouraged him to withdraw his funds as well. I remember joking that you never know, this could even be a Ponzi scheme.

The Edge closes down

Months later, I heard that Bill was closing down The Edge and returning all funds to investors, he was unhappy about disparaging rumours about The Edge. He then revealed he was going to continue with a smaller group of investors in another scheme. I found this reassuring for John, it put at rest any fears that this was a Ponzi scheme/scam as returning investor funds would uncover any large holes if the returns were being made up. In the meantime, I encouraged John to continue to withdraw funds, I still suspected a greater deal of leverage was being used than previously and he sounded like he had a considerable amount of money in there.

More volatility, better returns – Red flagRisk

Over the years since, we’ve spoken a couple of times about (what was previously) The Edge, and last year John told me they had made their first loss in a quarter. As a result Bill and his partner were amending the system as a result. Bill expected that this would mean “more volatility but better returns”.

As an adviser, this is an immediate red flag to me and I explained that what he’s saying here is “I can’t make enough money with the system I’m using, so I’m going to take more risk in the hope of better returns”. Again this is kind of reassuring that returns were reducing, and any system needs to be revised. However, if this was a fund manager, my view is that I would want them to reduce their overall risk while trying out a new system, later on increasing the risk once they have established that the new system works. I told John if this was a hedge fund with my client’s money, I would tell them to pull everything out immediately and that he should withdraw everything.

The cracks begin to show

Earlier this year, John told me there had been delays in returning investor funds at the end of the quarter. I explained that on this information alone, I would withdraw everything I could. In the investment world, a fund manager that is struggling with redemptions is usually the first sign of a product failure. Furthermore, it didn’t make sense, surely a betting syndicate places bets on say a Saturday and gets paid on say a Monday. The majority of the money should be in cash and readily available unless it was tied up in some sort of term deposit which was outside of what you would be expecting Bill to do. “Either way John, get your money out as soon as you can”.

Since then there have been a number of desperate sounding emails from Bill to investors as he seemingly played for time over the last 6 months telling investors he was winding up the scheme.

All gone!All investments gone

If you have been following the story in the papers, you’ll have seen Bill’s deeds come to light. A group of disgruntled investors took Bill to court this month for a return of their $26 million investment.

It’s rumoured that there was $200-$500 Million invested in Bill’s syndicates. As soon as I heard of the size of the syndicates in the press, I felt it was pretty clear this was a Ponzi scheme and reported it accordingly.

Although John still retained a significant investment at the end which I suspect has all gone, I was glad to hear that my warnings hadn’t fallen on deaf ears and he had withdrawn a large part of his holding over the last couple of years.

He was one of the lucky ones. Each day, the authorities are uncovering more investors who remained in there, ploughed their hard earned savings and had borrowed to invest. For their and Bill’s sake, I hope the funds are still there but I suspect that there is nothing.

So assuming this is a scam, whose fault is thisWho's fault is it?

I have thought a lot about this over the last couple of weeks. The public perception seems to be only the greedy or stupid would invest (20/20 hindsight indicates this is clearly a scam). I disagree, this was a punting club where entry was only through friends who had typically been in this for years and had made a lot of money. No one was actively recruiting new investors.

I place a lot of trust in my friends and make no apologies for that, I trust them implicitly, that’s why they are my friends. We are a society that prides itself on treating people fairly. So consider this, if you start with the premise that a lot of your friends are in this investment, that this has been running for a number of years, that it has paid out actual income, and finally, it’s a friend of a friend who is running the club whose occupation (psychologist) is publicly perceived as ethical. I don’t think that it’s obvious at all. I could make the same argument about the long held belief that property doubles in value every 7 years!

I also firmly believe that I could have worked this out had I spent a little more time questioning it but I didn’t have any clients invested and once I put my adviser hat on I ceased to invest, and told my friend to get out.

Aside from the belief in Bill not ripping off his friends, I didn’t work this out because it’s not my role to work out if an investment is a scam, my role as an adviser is to work out if you are getting rewarded for the risk you are taking. What I worked out was the returns were great but the risk I was taking for that return could not be measured. Part of this risk analysis is understanding what is going on under the hood and if I don’t understand it or it doesn’t make sense I don’t recommend it to my clients.

Probably the hardest skill to develop is the ability to correctly assess risk and to get adequately rewarded for this. We often place too much emphasis on friendships and familiarity when assessing risk. A typical example is the overabundance of bank stocks in what a self directed client considers a “diversified” portfolio. So it doesn’t surprise me to hear investors have placed their life savings or borrowed to invest into a scheme like this, investors don’t typically have the skills to adequately assess investment risk.

Let’s point the fingerExamining the reasons

Whilst ultimately, each individual is likely to question their rationale for investing, I don’t think most investors should be too hard on themselves. This is likely the fault of a man named Bill and only he can explain what actually happened. Was this something that started as a small scheme and worked for a little while before he lost money and made up the returns, which then ballooned into a large scheme, or was this a scam from the word go? I doubt we’ll ever know.

I blame Bill but I also apportion guilt to the Australian Securities & Investment Commission (and the Federal Government by default) for not regulating small betting syndicates and which perpetuates a gambling mentality in our society. A Federal Government that finds it acceptable that our pubs are filled with pokie machines, which instils a gambling behaviour into our children from an early age. A Government that encourages investors to take large risks in the share market or investing in property with margin loans and negative gearing. Arguably, a Government that perpetuates the take a punt mentality rather than knuckle down and save.

If you’ve become an unfortunate victim of this alleged scam, you’re probably beating yourself up over how stupid you have been, the press is inundated with quotes of how stupid and greedy investors must have been to have put money in this scheme. My message to you is don’t beat yourself up over it, you’re only guilty of extending the trust you place in your friends, to their friends. You’re not trained to assess risk versus reward in the same way that professionals such as financial planners are. Hindsight is always 20/20.

If you have been caught in this investment, I would encourage you to report it to the police. I suspect the temptation for most is to keep quiet, avoiding both the pain of investment loss and the feeling of stupidity by investing in something labelled as an “obvious scam”.

Your only hope is to help investigators understand the magnitude of this, ensuring whoever is responsible is accountable, and hopefully you may be able to recover a small amount of your money back.

Lessons for us all

I think the key lesson for the rest of us is to ask yourself how you assess and manage risk in your own investment decisions. As financial planners we often see clients who come to us having managed their own affairs blinded to the risk of investment, with large proportions of their portfolios in a handful of investments. This is typically because our familiarity with the brand means we place a higher degree of trust than if we were doing due diligence on an unknown company.

As planners we are obsessed by risk and is one of the key value adds in our clients receiving advice. In effect, our clients outsource their risk management by engaging us.

We manage risk by limiting exposure to high risk investments and proportion this in line with your overall attitude to risk. We also use a range of managed funds, listed investment companies, ETFs and direct holdings as a way of diversifying risk in portfolios. Yes it’s more expensive than owning a handful of shares, but our aim is to produce the best return for the risk of investing for our clients. We encourage you to do the same.

If, as a victim, you are concerned about what could happen if you were to take the matter further and whether you would thereby be personally exposing yourself to some further risk or liability, financial or otherwise, then Stewart Levitt of Levitt Robinson, Solicitors of Sydney, is willing to advise you confidentially, on a case-by-case basis, of where you stand. Levitt Robinson solicitors can be contacted on 02 9286 3133