Thursday, February 18, 2010
Standard deviaton: equal- or asset-weight
Way back in 1997, when the AIMR Performance Presentation Standards (AIMR-PPS(R)) introduced the requirement for firms to disclose a measure of dispersion, they encouraged firms to show asset-weighted standard deviation rather than equal-weighted, because, after all, the composite returns were asset-weighted, why shouldn't dispersion? AIMR introduced a formula to do just this.
Well, a funny thing happened when we went to the last edition of the Global Investment Performance Standards (GIPS(R)) in 2006: nowhere do we find the asset-weighted standard deviation. Where did it go? The Handbook provides the math to derive the equal-weighted measure but not asset-weighted. Other than in Q&As, we see nary a word on asset-weighting. Is this a sign of a change in belief in the value of the asset-weighted approach? I believe it is, although firms can continue to show asset-weighted, if they would like.
But why would you? How do you interpret or explain it? Equal-weighted standard deviation has an understood meaning, but asset-weighting, to my knowledge, doesn't. It's more complex to derive and provides you with what benefit? And, why would using the beginning of the year market value for an annual measure improve upon the tried-and-true equal weighted standard deviation? I say, put an end to this measure and go with the traditional one. It's easier to calculate, is more widely accepted, and is interpretable!