Having spent a few days in Las Vegas over the holidays, one is reminded of the lure of legerdemain. A few bells go off, some flashing lights and a win here and there can tempt even the most staid rationalist into believing that magic can happen. If you have seen “Chicago,” you may recall Billy Flynn's musical urging to “Give 'em the old razzle dazzle…Give 'em the old hocus pocus, Bead and feather 'em, How can they see with sequins in their eyes?”
On Broadway or at a casino, entertainment is the name of the game. investing is another matter altogether. By its nature and in contrast to trading, investing is typically thought of as an ongoing process with a long-term goal of satisfying one or more objectives. A disciplined and diligent investor will (hopefully) eschew gimmickry in favor of doing one's homework, ask questions and make sure that the answers make sense. Examining performance numbers is an important part of the exercise. Past is not necessarily prologue. Projecting future risk-adjusted returns is mission-critical. When a fund is new and has a relatively short track record, that work of assessing potential gains or losses can be challenging but certainly not impossible.
When numbers provided by an asset manager reflect smoke and mirrors, trouble is likely to follow. For one Massachusetts-based organization, its predicament took the form of an investigation and subsequent censure decision and fine. According to its December 22, 2014 order in the matter of F-Squared investments, Inc., the U.S. Securities and Exchange Commission (“SEC”) accepted a $35 million settlement regarding “recklessness” in how this registered investment advisor (“RIA”) advertised returns.
One grievance relates to its use of back testing to manufacture a track record of an equity product. Ignoring a “material performance calculation error” is another upset, with “virtually all of AlphaSector's claimed outperformance relative to the S&P 500 Index (SPX) for the pre-October 2008 period [being] attributable to this erroneous calculation.”
