Friday, January 13, 2012

Almost Everything We're Taught Is Wrong, well maybe not almost everything

Last year John Stossel wrote a piece titled "Almost Everything We're Taught Is Wrong." When it comes to performance measurement, there's some truth to this, too. Sorrowfully, many refuse to be open to the possibility that the way they've been doing or promoting something is fundamentally wrong. Is it pride, a refusal to be objective, impatience or frustration with those of us who challenge the "conventional wisdom," a resolute commitment to the traditional methods, or some other reason? 

I must confess I've been guilty of this, too. We learn something at an early age, and it gets reinforced along the way. Then, out of the blue, someone comes and says "no, there's a different way," or "no, what you're doing is wrong," or, "no, your understand is incorrect." How do we react? Our natural reaction is usually a defensive one: that is often the case with me. I have to learn to pause, listen, reflect, consider. A lot to ask, but really what's necessary.

Take Modified Dietz, for example. I was taught that it was a time-weighted rate of return: FULL STOP! That's it. And then I'm told (by my friend Carl Bacon and a few others) "no, actually it's a money-weighted rate of return." "WHAT!" And so, I turn to the literature, and nowhere do I read that this is true; on the contrary, everything points to it being a time-weighted rate of return. Carl is clearly mistaken.

Somewhere along the way I realized that (dare I say it?) Carl was correct. BUT, do I confess (mea culpa)? And, do I tell others? After all, just about everyone knows that Mod Dietz is time-weighted. By coming out with this revelation, won't confusion be rampant? Can the performance measurement industry stand such a jolt? Well, after much soul searching, I realized that regardless of the impact, the truth must be told: Modified Dietz is money-weighted ... unless, of course, you link it, and then it's an approximation to time-weighting (right, Steve?). 

But there is so much more that we do that is simply wrong; for example:
  • using the aggregate method for GIPS(R) (Global Investment Performance Standards) compliance
  • relying so heavily on time-weighting, when money-weighting is a superior method
  • requiring asset-weighted composite returns rather than (or, at a minimum, along with) equal-weighted composite returns for GIPS compliance.
Opportunities still arise for change, however. And it will come, eventually.

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