The Importance of Actual Returns In The Due Diligence Process

A webcast presentation originally held on March 9, 2016 by Mike Posey as part of the CMT Association’s Educational Web Series.

Everyone in the investment industry is very familiar with the disclosure, “past performance is not necessarily indicative of future results.” However, having spent more than 16 years of my career participating in due diligence reviews of third-parties, I know that large individual investors, institutions and third-party Investment Advisors are often drawn to impressive historical performance. After all, imperfect as it is, actual past performance beats whatever is in second place by a country mile.

That’s why, during the due diligence process, an actual track record is often the first item of documentation requested. It’s only natural that a due diligence team would want to verify the returns that attracted them to the Investment Manager in the first place. Unfortunately, the due diligence process is often derailed when it is discovered that all or part of a promising long-term track record is hypothetical, based on backtesting of a quantitative model after-the-fact.

The presence of hypothetical performance often represents little more than a best guess generated by a mathematical algorithm applied to historical market data. It is therefore important for the due diligence professional to understand the limitations of backtested data as well as know the advantages of actual performance that has been verified by an independent third party. This white paper will address both of these issues.

Thoughts and opinions expressed in this paper are based on the research and experience of the author and are not intended to constitute legal or compliance advice.

For purposes of this white paper, the tracking of actual investment performance will be defined in terms of managed accounts using quantitative model strategies in which one representative account reflects the performance of all similarly situated accounts.