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Random Comment: Hit Ratios and Skew in Investment Decisions

While digging for investment insights, we came across this paragraph. Bridgewater, incidentally, is one of the worlds most successful hedge funds, running around $140 billion.

The “58% winning percentage” figure caught our attention. It’s consistent with a couple of other data-points – in a podcast sometime back the co-founder of one of the UKs largest equity hedge funds referred to hit ratios of between 50-60%. And some years ago, one large equity manager remarked that their solid long-term track record came out of a 51% hit ratio.

What constitutes a “win”? In aggregate it might be clear – did you make money / beat your benchmark. But on a trade-by-trade basis, it could get a bit trickier. If you’re running a long/short equity book, it might be fairly clear – did your longs beat your shorts? But if you’re in a long-only world, where you’re competing against a diversified benchmark, it might get a bit more complicated to disaggregate your different positions.

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It’s also worth pointing out that the “hit ratio” – however it’s defined – isn’t the only driver for success. There’s at least one other critical factor – what you could call “skew” – how much do you make on your “wins”, compared to what you lose on your “losses”. A bigger skew means you don’t have to get quite so many trade ideas correct. A big enough skew and you can get more than half your bets wrong!

So, is 58% a high number or not? Well, the short answer is that it made Bridgewater extremely successful, so it’s probably high enough! But in much of the rest of the world, being wrong four times (or more) out of ten isn’t regarded as a mark of greatness.

Where does this get us? There are a couple of points worth making. First, as you might guess, we think it’s a reminder that successful investing is hard. Second, it’s worth keeping in mind in the context of buy lists (of stocks / funds) that you often see in brokerages. A Top Ten list somehow loses its appeal if you consider that getting six out of ten is a Hall of Fame result. Third, it also suggests that judging luck vs skill in investing is not straightforward – you need a lot of observations to come to any sort of meaningful conclusion.

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