The way data are presented should help understanding, not engender serious doubts.

At my request I was recently provided by an advisor with an analysis of two investment alternatives: a fund investing in private markets (that is, in non-public market opportunities, with limited liquidity) which the advisor was proposing to a client and an alternative in the form of a listed ETF. As part of the output, the advisor produced performance figures and the graph shown in Figure 1 (A is the private markets fund and B the ETF; 100 = begin 1q2008).

Figure 1

In the graph, returns for the ETF are adjusted to take into consideration the leverage used in A; in practice, B’s returns have been multiplied by a leverage factor to make it comparable (1).

Three things to notice immediately.

The first is the margin of outperformance by the private markets fund. Impressive.

The second is the smoothness of A’s progression. Remember: A invests in non-public markets; valuations and volatility may differ but should not be radically different. If something in the back of your brain screams ‘Madoff’ you are not alone but please put that thought aside as we are not talking (I think) of fraudulent representation in this case.

The third is that A seems to have flown through the last financial crisis (2008 and early 2009) amazingly unscathed: making money in the five quarters from January 2008 through March 2009 (blue line is always above 100 except in the 4th quarter 2009 and in the 3rd quarter 2010, when it marginally dips below). This should set off even louder screams from anywhere in your body: during the same period, virtually nothing made money except long US Treasuries and similar obligations from a handful of developed markets sovereign states. (At the end of a long string of emails on the subject, the advisor said ‘Why don’t you forget about 2008/1q2009… if you look instead at the performance in the last five years…’ I’m still mildly shocked.)

You may ask, ‘OK I get it but what is the big deal? Twelve years later A has still beaten the pants off B.’ Well yes, but then maybe not; the big deal here is: do you like paying for nothing?

Patterns of returns, starting points and comparability of valuation methodologies are very important in evaluating performance records, at least to get an idea of the nature, consistency, and stability of the investment process that generates them. If A’s manager was truly skillful in investing during the financial crisis and beyond then, perhaps, 12 years later you would be happy. But what if you were told that, taking those incredible 5 quarters away you’d get the graph in Figure 2 (100 = end 1q2009)?

Figure 2

How difficult then can it be? Very difficult(2).

Roberto Plaja, May 22, 2021


(1) Interestingly, or perhaps to make things more confusing, returns and visual impact change considerably if you instead ‘deleverage’ the results of A to make them comparable to B:

(2) As usual, in the above real example names and identities were kept anonymous. Perhaps I should not trouble with it: investors, not their advisors, need protection from unsavory or exceedingly commercial practices. Wouldn’t we all want to know the name of the doctor who rarely gets it right – whether willfully or for ignorance?

Cover: M.C. Escher, Bond of Union, 1956, lithograph.