I’m having some heated arguments at work regarding how to calculate performance for our fund. Was hoping I could get some opinions from people on this forum. We’re a startup fund with no clients and still trying figure out some really basic stuff.
Basically what we’ve got is unit trust fund that tracks a stock index. On the back of that we’ve got a separate mandate that enables us to take option positions on behalf of clients.
The argument is how do we account for the option premium and return in the performance calcs?
There are 2 arguments being debated using an analogy of investment in a house and buying home insurance premium to calculate performance returns.
So pretend you buy a house for $1M and you also buy insurance for $300K (big number for example purposes). A few years later you sell the house for $2M.
You made $1M profit on the house, but had $300K expense, so your performance is ( ($2M - $1M - $300K) / $1M ) = 70%
Your initial investment was $1.3M ($1M + $300K), and at the end you walked away with $2M, so your performance is ($2M - $1M - $300K) / $1.3M = 54%
I’m arguing for choice 2 but my boss (who’s got 15+ years derivatives trading experience) is saying that you can’t treat options in this way. He’s saying that the option premiums shouldn’t considered like upfront capital and that you should only be looking at the mark-to-market PnL on these for performance calcs (i.e not include premium in the denominator). One argument he is saying also which rings true is that if you only sell options (i.e. receive premium), then how would you calculate PnL (i.e. you’re exposing yourself to risk but haven’t put any money down except for margin).
The way I see it, you had to outlay $1.3M and you got back $2M, so the $1.3M should be the denominator in your calcs instead of only $1M.
Does anyone have any experience or opinions on this? I can see an argument for his method, but mine seems perfectly logical as well, but surely there must only be one correct way to do this.
Btw – does GIPS cover this kind of thing? Should I be looking there or is that for something completely different? I’ve only done L1 on it which is pretty brief.