A recent report has shed light on the intricacies and limitations of using backtested performance metrics as a strategy for making investment decisions. The findings underscore important distinctions to consider when evaluating strategies based on historical data.
The report clarifies that the Smart Score performance data derived from TipRanks is based on backtested results, which are not necessarily indicative of future performance. Backtesting reflects a strategy that was not historically available to investors, meaning that the actual returns achieved by any investor may vary significantly from those presented in the model.
One of the primary concerns highlighted is the use of historical data to predict future results. The methodology involves retroactively applying a model built from past data, which relies on several assumptions that may not hold true in actual trading scenarios. Some of these hypotheses suggest that the firm would have been able to acquire the recommended securities and that market conditions were sufficiently liquid to facilitate all trading activities.
The document cautions that if any assumptions change, particularly regarding market conditions or liquidity, it could greatly affect the backtested returns displayed. Certain assumptions, primarily for modeling purposes, are less likely to be fully realized in a real-world context.
Additionally, the report emphasizes that while backtested performance offers a detailed illustration, it does have inherent limitations. Specifically, it does not account for real trading experiences or the influence of economic factors on decision-making, which can significantly impact performance. Since transactions have not been executed in reality, the results may not accurately reflect actual performance—potentially overstating or understating returns due to the lack of liquidity or other market dynamics.
Crucially, backtesting enables the security selection methodology to be tailored to optimize past performance, raising questions about the validity of such strategies for future investing. The variance between actual performance and backtested results could be substantial, leading investors to approach reliance on these metrics with caution.
Furthermore, while backtested results are typically adjusted to include reinvested dividends and other income, they generally do not account for various fees and transaction costs that would apply in real-world trading. This omission highlights the importance of considering regulatory factors concerning fee presentations.
In summary, while backtested results can provide a compelling narrative of past performance, investors must recognize the limitations and assumptions underlying these models. Relying solely on historical data without acknowledging its inherent risks could lead to misguided investment decisions.
