Backtesting
One of those cognitive dissonances that, for now, has passed into embarrassed history, but is sure to re-emerge the moment the financial markets regain their resting state of giddy optimism fueled by the delusional self-confidence of vain men.
Back in the day, a resourceful salesperson with a clever new product (one that, you know, embedded leveraged alpha, or something) had to go through the motions of justifying its “extraordinary potential”[1] when pitching it to his marks[2].
The problem with financial markets was, is, and always will be this: you can’t anticipate the future. This isn’t a shortcoming of contemporary financial management techniques, by the way: it’s in a market’s very nature. If you could, you couldn’t make money betting on it.
You know the story about the frog and the scorpion, right?
So these randy salespeople needed something their clients could take back to their risk committees to demonstrate the rigorous financial analysis that had gone into their product design. The lightbulb moment was the invention of backtesting. There may be a total lack of data from the future, but there’s a shit-ton of the stuff from the past. Your Bloomberg terminal is your friend. All you needed was ninja Excel skills — every blighter has those — and you could compare how your fabulous strategy would have done had it been running in, say, the five years leading up to the present. Gregariously, you could extend the backtesting period over a known period of market shock, to illustrate how the strategy would have performed in a challenging market.
And how would it perform? SPECTACULARLY. Whatever the weather. Had the marks not been so credulous, you’d think they'd start to twig. Well, they worked it out eventually. The hard way.
Thanks to the “chart” function in Microsoft Excel could render these illustrations in multicoloured, three-dimensional boxes, graphs, Gantt charts and fishbone analyses. It was brilliant. In every case the strategy outperformed beta and any other indicator in the market that the salesperson cared to represent. But the restaurant booking was in twenty minutes, so the client had seen all he needed to see.
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References
- ↑ i.e., for sales credits
- ↑ Did I say “marks”? I meant “sophisticated clients properly categorised for MiFID purposes as professionals who weren’t carpet-bagging blaggers, had the slightest clue what they were about, effortlessly saw charlatans coming a mile off and weren’t remotely influenced by the corporate entertainment — golf, motor racing, fine dining and hookers — with which they were lavishly festooned”.