Saturday, March 10, 2007

Timing and Measuring Investment Performance

The chart shows how many percent you would be ahead of the MSCI World Index (Gross = total return index) today by investing with me in each of the months on the X axis. This shows the influence of timing of investments on performance. Measured from inception in October 1996 when I first started measuring investment performance you would be 10% behind the index. Investments made in late 2004, through 2005 would also be lagging in performance. But if you invested with me in any of the other periods you would be ahead by up to 47%. If, instead, one dollar cost averaged into this investment program - as I have done in practice - you would be beating the market, as investing in most months results in index-beating performance.

I think a chart of this sort would be very useful as part of every mutual and hedge fund prospectus or as a feature of websites such as Yahoo Finance.


Anonymous said...

Nice blog, its quite refreshing compared to all the long-only baised bloggers out there in the blogsphere.

What is the reasoning behind using MSCI World as your benchmark? With all the hedging why not HRFX Absolute Return or Global Macro Index?

mOOm said...

Thanks for your comments. Would appreciate if you can point me to where I can download data on those indices you mention. I guess my point in using the MSCI world index is to see how much value I add by deviating from a global long only stocks portfolio which is where the conventional wisdom is at. My correlation with the SP500 total return index is lower and my alpha higher due to diversifying across countries. I do keep track of that, but anyone can diversify globally in stocks so that seems a useful benchmark.

I'm a bit skeptical of tailoring the benchmark too closely to a precise strategy... eventually you could explain away most or all of the managers skill in that fashion if taken to an extreme. Using a long-only stock index as the benchmark seems to come closer to answering the question: "Am I beating the market?". I also compute things like the Sharpe Ratio (where risk free interest is the benchmark effectively).

Anonymous said...

What is your correlation to the MSCI World Index? If the correlation is low, then the alpha and beta derived from it may have little meaning.

Rich Gates

mOOm said...

Hi Rich

R-squared for the 36 months through this month to date is only 0.22. A correlation of 0.47. Beta is 0.77 with a t-statistic of 3.12. As the monthly rates of return are pretty stationary (rho = 0.4) that is highly significant. Alpha though is 9.51% and it's t-statistic is 1.22. So there is a larger probability (around 12%) that the true alpha is zero or less. For the S&P 500 the r-squared is just 0.10. Alpha is larger and more statistically significant there though. The annualized Sharpe ratio is 1.32 for the same period (compared to 1.49 for the TFS Market Neutral Fund since inception).

So I think the results are statistically meaningful. Even with an insignificant beta a significant alpha would be telling you that you were getting a consistent return that wasn't correlated to the specific index in question.

Anonymous said...

They produce a monthly flash which anyone can access however you need to purchase an account to obtain historical performance data. I guess my biggest reserve against using MSCI World or S&P 500 as a benchmark is that they both do not produce a totally diversified portfolio eliminating un-systemic risk so it cannot replicate the optimal portfolio but also it compares different universes of return/risk profiles from yourself. For example if you are in your 70s and want capital preservation and hold most of your assets in fixed income securities you are not going to compare yourself to someone who is in their 30s and hold most of their assets in stocks. The difference of returns between their respective benchmark is not from alpha but taking different levels of beta and difference of time horizons.

If your goal is to produce alpha, why not compare yourself to others who also are seeking to produce alpha. But at the end of the day if you made money in the market it’s all good regardless of how much money other people made.

mOOm said...

Thanks! I guess I am not so much concerned with whether I am outperforming someone else who I can't really invest with anyway but how I am doing relative to what a default passive buy and hold portfolio would be. Would my default be 100% in the MSCI All Country Index? If not even allowed any rebalancing it might be as I can't see bonds or many other assets really outperforming stocks in the long run given current yields. If allowed rebalancing at least then probably not 100% in that asset class. But then I'd need to construct a rebalancing benchmark.

Anyway, it's just one of the statistics I come up with. It would be nice to see more bloggers producing even total return indices over reasonable lengths of time so we could see how different approaches are working. It's not hard if you know how much you made and what your net worth is each month.

Unknown said...

Hello mOOm!

Great blog, i just discovered it. Really the most informative i've come across yet! Sad to see that its been quiet recently. I guess you are not as interested in maintaining it anymore? I'am reading it back to front right now :). Can you elaborate a little on the math behind the chart you posted here?

Thanks very much in advance!