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A Decrepit Decade Just Keeps Getting Worse
By Ron Surz 
October 6, 2008

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Make lemonade when the market gives you lemons: Winning the Losers Game

This is one of those unfortunate times when consultants and investment managers will try to console their clients by explaining how their pain is less, hopefully, than most others. This will be awkward and delicate, and is likely to bring forth the difficult questions about bailing or doubling down. As for good relative performance, we’ll need to look back 3 years or more to find a timeframe where positive returns are winners because that is when the S&P500 rises back to zero. The 3-year annualized return for the period ending 9/30/08 is 0.22%.  As the following exhibit shows, a 15% loss will win the year-to-date performance race for those who are benchmarked against the S&P500, because a -15% return ranks in the top quartile for the 9 month period ending 9/30/08. “Congratulations Mrs. Client your manager performed very well, losing “only” 15% of your account in the year to date.” Talk about pain management.

The universes in this exhibit are created using an unbiased scientific approach called Portfolio Opportunity Distributions (PODs). They represent all of the possible portfolios that managers could have held when selecting stocks from the S&P500. Traditional peer groups are very poor barometers of success or failure because of their myriad biases. Everyone knows that it’s easy to find a peer group provider that makes you look good, but for some reason the industry tolerates, even condones, this deceptive practice. PODs are bias free and are therefore a much more reliable performance evaluation backdrop, plus they’re available now, many weeks before the “real” biased peer groups. As John Stossel says on ABC TV News:”Give me a break.” You can use the chart below to get an early and accurate ranking of your own portfolio -- just plot your dot.

S&P Opportunity Distributions

Putting it all together: Attribution Analysis

PODs create a fair performance competition, but regardless of whether you’ve won or lost this competition, inquiring minds want to know why. This is the purpose of performance attribution: identifying the reasons that performance is good or bad. Unfortunately, attribution analyses are frequently performed against a crazy reference, contrasting sector allocations and stock picks to the S&P500 even though the manager is nothing like this index. It’s the old garbage-in-garbage-out, or GIGO, problem. If the benchmark is wrong all of the analytics are wrong. As a former acquaintance used to say, “I mean this in the kindest possible way: Stop this benchmark insanity. Please!”

To flip this craziness on its ear, and provide some perspective on attribution analyses in the past nine months, we attribute performance for the S&P500 using the total U.S. market as the benchmark. Why does the S&P perform the way it does relative to the total market? We use an attribution system called StokTrib, described at   http://www.ppca-inc.com/Stok_Trib/stoktrib.htm, to answer this question.

As shown in the following exhibit, the S&P500 has matched the performance of the total US stock market because of offsetting failures and successes: good sector allocations were offset by poor stock selections. The S&P usually performs differently than the total market, so this time period is unique. The value tilt of the S&P currently weights Staples and Health Care more heavily than the market, while underweighting Materials, all of which were beneficial. But the stock picks of the committee that selects those 500 stocks offset this benefit. Yes, the S&P is a managed portfolio, albeit managed by committee. Attribution analyses that are careless about the benchmark, using the S&P500 for all managers, will signal good stock picking in the Energy and InfoTech sectors because the S&P is easy to beat in these sectors. That is, investment managers will receive undeserved accolades. 

YTD Attribution Analysis

Only the strong survive: Hedge funds

So how about hedge funds? Can we hide there? As the following exhibit shows, most hedge fund strategies delivered on the “hedge”, losing less than the market, with a few even delivering positive results. The average Global Macro manager delivered a 2.5% return during the past 9 months, which contrasts to a 24% loss in the worst-performing Convertible Arbitrage strategy. As noted in the previous section, a 15% loss puts you into the top quartile of traditional long-only managers. Six of the eight hedge fund strategies have lost less than 15% year-to-date. Also, the range of performance within hedge fund strategies is quite large, so it matters a lot who you use within a specific strategy.

Yes, there has been a place to hide, and it’s been in hedge funds, especially Global Macro hedge funds. Global Macro hedge funds are a disperse group with a general commonality of currency investing. Their good relative performance suggests that on average they got the US dollar right. 

Hedge Fund Returns


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