Ben Carlson wrote a great piece yesterday explaining survivorship bias in hedge fund indices. He used the infamous Long-Term Capital Management (LTCM) as an example. LTCM was full of brains (think PhD’s and Noel Laureates) but had a spectacular downfall. Interestingly, only the positive results of LTCM’s returns history are included in most hedge fund indices. At some point when LTCM started doing badly, they stopped reporting returns data which meant index providers stopped recording their results. This is an example of survivorship bias which is far too prevalent in finance.
Ben highlights the following to consider when looking at data:
- Understand your sources of data.
- Never blindly accept facts and figures about the markets just because they contain decimal places.
- All numbers require context.
- Look for holes in the data and your own thinking.
- Don’t forget about implementation costs and behavioral issues.
- You can use historical data to guide your actions, but always be aware of the limitations.
Read Ben’s article here.