# The Investment Scientist

## Archive for July 2021

### Another Example of Return and Volatility Manufacturing

Posted on: July 25, 2021

Last week I shared an example of I ended the article with five questions:

1. Can the average return tell you if you will make or lose money?
2. Can the average return tell you how much money you make or lose?
3. What else determines if you make or lose money?
4. Why do hedge funds love to use average returns?
5. Why do I use asset class diversification to reduce client portfolio return variability? (Note that this will make the return number look smaller.)

1. No.
2. No.
3. Return variability or volatility. It is also called volatility drag – the higher the volatility, the lower the return. Here is
4. It’s great for marketing.
5. One word: I am a fiduciary. (Ok, four words.)
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### Can You Lose Money on an Investment With a 20% Average Annual Return?

Posted on: July 18, 2021

Sure you can! Look at the following stylized example.

Hedge Fund A has a first-year return of 100%, and a second-year return of -60%. The hedge fund’s average return is (100-60)/2 = 20%. But if you have invested \$100k in this hedge fund, by the end of the second year, you will only have 100*(1+100%)*(1-60%) = 100*2*0.4 = \$80k. In other words, Hedge Fund A gives you 20% average annual return, but you still lose \$20k or 20% of your money!

What gives?! Let’s look at the following 6 investments, all of which have a 20% average return. Some are profitable and some are not. All assume an initial investment of \$100,000.

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### What Oxford Taught Me About Private Equity

Posted on: July 14, 2021

Today I finally finished the Oxford class on Private Equity, and I’d like to share with you, my readers, some of my takeaways.

Long-time readers of my newsletter should know that I have long advised against investing in private investments unless 1) you know the business and 2) you have a measure of control. The reason for this is that private investments are not under the purview of the SEC, and thus provide a fertile ground for conflict of interest. After the Oxford course on private equity, I feel completely vindicated.

Some of my readers, if you are wealthy enough, will be approached with private equity investment opportunities. You will be presented with mouth-watering return numbers. My professor called these numbers complete “garbage,” they can be manufactured (but not fabricated.) Fabricating numbers is against the law, but manufacturing numbers is not, and there is only a hair’s breadth separating them. Next time you see a number like 36.8% annual return, think “manufacturing” and don’t waste your time! I will show you how they manufacture numbers in the next article.

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### Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.