Economics and similar, for the sleep-deprived

A subtle change has been made to the comments links, so they no longer pop up. Does this in any way help with the problem about comments not appearing on permalinked posts, readers?

Update: seemingly not

Update: Oh yeah!

Tuesday, December 22, 2009

Risk-adjusted performance - a squib

It is, of course, a truth universally accepted that active money managers are timewasters and charlatans and that any occasional outperformance they ever generate is simply the result of excess risk-taking. This point has been belaboured so often by Nicholas Taleb on one side and the index-fund cultists on the other that I have long since given up arguing otherwise. However ...

The 2009 performance year is coming to an end, and some fund managers will have outperformed massively and some underperformed massively. In general, across the sector, whether you underperformed or outperformed will depend on one thing alone - whether you went long financials in mid-March. More or less nothing else will have made enough of a difference to move the dial compared to that - for quite a long period at the end of Q1/beginning of Q2, the underweight financials position would have been costing your average manager as much as 50bp of relative performance a day.

On the other hand, think back to March of this year. Would "men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested" really have gone all in on financials, the week after AIG announced the largest loss in corporate history at that time? What sort of risk were people taking who made what was objectively clearly the right decision? What would Taleb say about the big outperformers of 2009, and what does this imply about how one should judge the risk of the underperformers? Given what we know about the performance of people who invest in index funds (much worse than the funds themselves[1], because they tend to get scared at market bottoms and take their money out).

I think that March 2009 is clearly a reductio ad absurdum of the notion that risk can meaningfully be measured by standard deviations or that the CAPM alpha can ever be used as a metric of investment performance. By the way, although I certainly don't propose to discuss my own performance this year in blog comments, this is not sour grapes.

[1] And the funds themselves often have really quite terrible performance relative to the indices they are meant to replicate - one should be aware that when using the Vanguard SP500 tracker, this is basically the Warren Buffet of tracker funds, and if you believe that it can continue in future to generate the exceptionally good tracking-error result that it has generated in the past, then this ought to have implications for your beliefs about the possibility of persistent performance in other areas too.
26 comments this item posted by the management 12/22/2009 01:18:00 AM

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