What happens if you use the wrong stats?

Continuing our discussion of Michael Lewis' Moneyball, I think there's a HUGE parallel between baseball statistics and what we do in investment performance measurement. Both deal with measuring performance: the performance of baseball players / the performance of money managers.

Lewis points out that for the first 150 years of baseball, the wrong statistics were used to evaluate the performance of players. As a result, the wrong ones were often rewarded and chosen, resulting in teams not doing as well as they had expected, given the "talent" they selected.

While investment performance's history is much shorter than baseball's (roughly 40 years), we have had the same challenges because we quickly adopted certain measures (e.g., standard deviation for risk, time-weighting for performance) which arguably are WRONG much of the time! And so, what's the consequence? Misleading information, misinterpretation of results, mis-allocation of resources.

Not everyone in baseball has "signed on" to the new statistics, although those who haven't will continue to suffer. The same can be said in our industry, where most firms have yet to see the wisdom of alternative measures. We should be glad that it hasn't taken us 150 years to figure out the error of our ways.