Performance Analysis
Torturing the Numbers Until They Confess
The use and misuse of performance numbers is quite legendary in the investment world. Those in the business of marketing investment products always try to put their best face on all the numbers. For example, if the five-year number is not beating the benchmark, then the focus will become the three-year number. If that fails they can always resort to changing the benchmark. The regulators take a dim view of misusing performance data. Unfortunately for investors there is nothing particularly illegal about the above changes, although the ethical lines in the sand experience a strong windstorm.
This abuse is even more apparent in the dark recesses of the hedge fund world. Although it is one of the most-quoted statistics, how well or poorly a fund is doing as measured over a discrete time period is the subject of ongoing and sometimes heated discussion. This discrete series of numbers undergoes extensive slicing and dicing in an attempt to more fully understand how they truly perform. Maybe the most important truths being sought in the torture of performance numbers is: As an investor, are you being paid a sufficient premium for the risks you are incurring? Performance of hedge funds is typically discussed in absolute terms. Investors will measure their returns against a desired benchmark and appropriate peer groups. The performance numbers serve as the guiding light for hiring (or firing) a manager, and in many ...

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