Existing measures of portfolio performance are leading investors to allocate capital to the wrong funds by misrepresenting risk. Current practice rests on false notions that risk can be treated separately from opportunity, risk can be derived from return distribution, Gaussian tools are valid for any return profile, volatility of returns is a proxy for risk, and returns should be adjusted for risk. Corrective action by the investment community can produce a huge payoff in productivity of investments from better allocations, but requires a rethinking of risk fundamentals to arrive at improved screening of funds. We must first cease to confuse the opportunity/risk management that precedes every investment decision with the gain/loss that results from an aggregate of decisions. The subject is not an academic exercise in technique; it is a significant challenge to all participants in the practice of mutual fund and hedge fund investing.
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