Monthly Letter May 2013

Outliers need to be understood. It is discomfor ng when something is not behaving the way it is supposed to do. The will and the need to understand are crucial to us all. That goes for the nancial industry and pre y much any other industry we can think of. It is rare to meet fellow investors or companies that claim they don’t care whether they understand something or not. Even if they truly didn’t care they are unlikely to ever admit it. There were some very interes ng market events in May such as Japan’s quan ta ve easing and the Federal Reserve’s “tapering or not” that would normally warrant an inclusion in this month’s le er but we’d prefer to explain our performance instead.

We will take a qualita ve rather than a sta s cal approach to explaining how May’s performance was generated. One of the more famous sta s cal expla- na ons was David Viniar, the Goldman Sachs CFO, explaining just how unlikely the losses in their Alpha fund had been in the turbulent days of August 2007 when the conduits started to come out of the shadows. The fund had, accord- ing to Viniar, “25 sigma events for several days”. We nd it hard to interpret what events outside of 2 standard devia ons mean, 25 is so far out on the tail that if it happens, especially on consecu ve days, it just shows that the model was wrong or that the interpreta on of the model leaves something to be desired.

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