Thursday, September 10, 2009

Science: fact or fiction

I understand that there is no universally agreed upon definition of what science is, and that's probably a good thing. But I suspect most people believe that science results in facts. We sometimes hear something being "art and not science, suggesting that art is perhaps a bit more "squishy," where we may be less likely to agree upon single answers, whereas science should result in objective results that yield universal agreement.

Yesterday, my son Chris and I were returning from a trip to Delaware when I asked him whether glass was a solid or liquid. He immediately responded "solid," whereupon I told him that when I was in my high school physics class some 40+ years ago I was told that glass is a liquid because it "flows." Well, he immediately turned to his trusty Blackberry to discover that this previously oft cited belief was wrong and that glass is classified as a solid. Okay, so science 40 years ago said "liquid," while today it's "solid." What happened? Definitions, rules, research?

I then mentioned that when I was in school Pluto was the 9th planet, but now is no longer considered a planet at all. Again, his Blackberry provided a conflicting answer, stating that although there was consideration to remove Pluto from the ranks of planets, the decision apparently was reversed.

And so it looks like science is becoming more art itself!

If scientists can change their minds about glass, Pluto, and much more, shouldn't we in performance measurement be prepared to change our minds, too? Unfortunately, many hold certain rules as almost sacrosanct, and refuse to consider that perhaps long standing traditions (such as the universal application of time-weighting) cannot be reconsidered. Fortunately, there are enough of us pushing for change that we are seeing some movement ... slow, yes, but movement nonetheless.

p.s., did you know that yesterday, at 9 seconds after 9 minutes after 9 o'clock, it was 09:09:09 09/09/09? Won't happen again for 100 years.

3 comments:

  1. My calculus teach once said this, math could be used and expressed in almost any situation (logic, game theory, imaginary numbers ...etc). My accountant professor also said this, in event of a difficult situation (non-material or sometimes material), the transaction could be place into miscellaneous ledge. Besides science, it seems art (human judgement) could be applied to both in math and accounting.

    When you state time weighted, I'm think you're referring to return calculation (I normally call the rate of change calculation and people at work think I'm crazy). I believe you and several authors (never read the papers but would love to) prefer to use IRR method. I'm guessing people prefer not to use IRR because the mechanic is less intuitive than time weighted or modified dietz calculation.

    When I receive my monthly statement, I don't look at the return or try to recalculate the results. IRR, time weighted, modified deitz, wealth ratio all have their own limitations.

    A dollar saved is a dollar earned. I feel a lot easier to rely on the month end market value to determine my wealth / earning. What do you think about my method?

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  2. Thanks for your comments. Actually, IRR is usually MORE intuitive than time-weighting; time-weighting continues because of "TRADITION"! Its complexity is handled quite well by software.

    As for looking at the dollars, yes, this is a good gauge, but doesn't tell you how you're doing from a performance standpoint, where IRR and TWRR have their value. Both have their place ... not saying get rid of TWRR by any means.

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  3. I agree. Computer power has help improve the performance calculation process but at the same time the theories and mechancis behind the calculation has been slowly forgotten.

    The birth of these different calculations comes from the issue related to the cash flows. Assuming there are no cash flow activities, I would assume the results would be similar with most fo the equations (I'm not 100% sure about IRR but would guess the results would be similar).

    If there were cash flow activities, assume the accounting side are all posted correctly, we might expect different returns. Assuming the portfolio had excess cash available for redemption or decided not to fully invest with the new money, the differences thus would be caused by the type of equations used, the magnitude of the cash flow, and the portfolio market value changed when the cash flow occurs.

    Besides the decision of the cash flow, the big assumption here is the accounting side. If the posting of cash flow date changes from one date to another, the result could differ. As long as cash flow/accounting issue is not raise, I'm sure TWRR is here to stay.

    The reason I stated IRR was counter-intutitive is because people would mentally use wealth ratio to estimate the return. It'll be difficult to repeat the same process when cash flow is involved.

    Yes, computer programs (I like to use excel) can help facilitate the calculation but rarely would I see people calculate returns during internal meetings (maybe your case is different).

    Finally, if we compare our results (relative analysis), yes we need to know the returns. However, if we need to know our wealth, I still think market values is a better choose.

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