03.23.2012

The Track Record

03.23.2012

There are both famous and unknown portfolio managers in the hedge fund space that tout superior track records. Past performance in triple digits, low management fees and a small lock up period are things that institutional and high-net worth investors can only dream of. And while the aforementioned situations do exist in rare cases, past performance isn’t an arbiter of the future.

One hedge fund manager is circulating his ideas around Wall Street. A young PM, he is a firm believer that upstart funds should be given a chance based on extensive back-testing of proprietary quantitative trading models. His paper is called “TRACK RECORD: The Lazy Man’s Due Diligence.”

“PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS,” writes the manager. “Eight simple words required by regulators and designed to protect what is always presumed to be the defenseless investor. However, its meaning is surprisingly ignored by the industry professionals themselves. The paradox of this concept is that if it is true, which logically it is, a ‘track record’ would be as useful (read: useless) as back-tested results.”

To the large institutional crowd, the paper may appear at face value to be contradictory to the norm of allocators and investors in new hedge funds. There’s really no negative context to the argument about past performance. The problem is that no arguments are against a back-test while in favor of a track record.

The point is that funds large and small should focus on due diligence and proper risk management techniques rather than relying on the underlying investment strategies and “distorted view” that just because an asset performs exceptionally well, that a fund manager can preserve capital and capture alpha.

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