What Is Cherry Picking Performance?
Cherry picking performance refers to the unethical and often misleading practice of selectively presenting positive investment performance data while omitting less favorable results. This tactic, a subset of behavioral finance, distorts the true historical return profile of an investment, strategy, or portfolio, creating an inaccurately favorable impression. It undermines transparency in financial reporting and can significantly mislead potential investors who rely on past results to make financial decision-making. Cherry picking performance can manifest in various ways, such as highlighting only winning trades, showcasing only top-performing accounts, or presenting returns for only specific, advantageous time periods.
History and Origin
The practice of selectively presenting financial data has likely existed as long as there has been a need to impress or persuade. In the investment world, as financial markets became more complex and the role of investment managers grew, the potential for misrepresentation also increased. The rise of modern portfolio theory and the emphasis on quantifiable investment performance led to more sophisticated methods of analysis and, unfortunately, also to more subtle forms of cherry picking performance.
Regulatory bodies and industry associations have long recognized the detrimental impact of misleading performance claims on investor confidence. Efforts to combat cherry picking performance have led to the development of stringent rules and ethical standards. For instance, in the United States, the Securities and Exchange Commission (SEC) enacted a modernized Marketing Rule which explicitly prohibits investment advisers from "cherry-picking performance results or presenting time periods in a manner that is not fair or balanced."10 Similarly, the Financial Industry Regulatory Authority (FINRA) enforces Rule 2210, requiring all communications with the public to be "fair and balanced" and to include all "material fact[s] or qualification[s]" necessary to ensure they are not misleading, which inherently addresses cherry picking.9
Globally, the CFA Institute developed the Global Investment Performance Standards (GIPS), a set of voluntary ethical principles designed to ensure fair representation and full disclosure of investment performance. The GIPS standards explicitly aim to prevent practices like cherry picking by requiring firms to present a comprehensive track record, often including a minimum of five years of GIPS-compliant history, building up to 10 years.,8 These standards represent a significant industry-led effort to standardize financial reporting and promote ethical conduct across capital markets.
Key Takeaways
- Cherry picking performance is the deceptive practice of presenting only favorable investment results while concealing less desirable outcomes.
- It distorts the true picture of an investment's historical returns, making it appear more successful than it is.
- Regulatory bodies like the SEC and FINRA, along with industry standards such as GIPS, have specific rules and guidelines to prevent cherry picking performance.
- The practice undermines transparency, damages investor confidence, and can lead to poor financial decision-making.
- Investors should conduct thorough due diligence and look for comprehensive, independently verified performance data across all market cycles.
Interpreting Cherry Picking Performance
Identifying cherry picking performance requires a critical eye and an understanding of comprehensive financial reporting practices. When evaluating investment performance data, it is crucial to look for complete transparency. A key indicator of potential cherry picking is the absence of consistent, long-term performance data, especially across varied market cycles, including downturns. Investors should be wary of presentations that only show short, favorable periods or that lack clear disclosures about the methodology used.
Legitimate investment managers typically provide performance figures that include all portfolios managed with a similar investment strategy, or they present a composite of relevant accounts. They also adhere to regulatory requirements, such as those from the SEC, which stipulate that advertisements must show performance for one-, five-, and ten-year time periods, or the life of the portfolio if it did not exist for those periods, with all periods presented with equal prominence.7,6 This standard aims to counter the tendency to cherry pick performance by forcing a broader, more balanced view. When evaluating an investment, always consider how the displayed performance fits within the broader context of the firm's overall portfolio management and historical results.
Hypothetical Example
Imagine an investment advisor, "Alpha Advisors," is trying to attract new clients. Their marketing brochure highlights a "stellar 25% return" achieved last year by their "Growth Equity Strategy." However, upon closer inspection, the brochure only shows the performance for that single, exceptionally good year. It omits the two preceding years, which saw returns of -10% and -5% for the same strategy.
This is an example of cherry picking performance. Alpha Advisors selectively chose to present only the best single-year return, ignoring the less impressive (and even negative) results from other recent periods. A more complete and transparent presentation would show the performance across all relevant periods, ideally for at least one, five, and ten years, allowing a prospective client to assess the risk-adjusted return and consistency of the investment strategy over time, including periods of market volatility. An investor performing proper due diligence would ask for these missing periods, or consult third-party verified reports.
Practical Applications
Cherry picking performance is a significant concern across various facets of the financial industry, impacting investors, regulators, and market integrity.
In investment management, firms are legally and ethically obligated to present performance fairly. The SEC's Marketing Rule, effective November 4, 2022, consolidated and updated guidelines for investment advisers, explicitly prohibiting cherry-picking performance results. The rule requires that if gross performance is shown, net performance must also be presented with at least equal prominence, calculated over the same period and using the same methodology.5,4 This reinforces the need for accurate financial reporting.
Regulatory bodies like FINRA and the SEC frequently examine firms' advertising and communication materials to ensure compliance with rules designed to prevent misleading claims, including those related to cherry picking performance.3,2 Non-compliance can result in substantial fines and disciplinary actions.
For investors, understanding cherry picking performance is vital for effective asset allocation and selecting appropriate investment strategy tools. It underscores the importance of not relying solely on marketing materials but instead seeking independent verification of performance data, examining comprehensive track records, and prioritizing firms that adhere to widely accepted ethical standards like GIPS. This due diligence helps protect against decisions based on incomplete or manipulated information.
Limitations and Criticisms
While regulatory efforts and industry ethical standards aim to curb cherry picking performance, the practice remains a persistent challenge due to its subtle nature and the inherent informational asymmetry between investment managers and potential clients. One primary criticism is that even with strict rules, firms may find ways to present data selectively without outright violating technical requirements. For instance, they might focus on specific segments of a broader portfolio, or use benchmarks that flatter their results, making their investment performance appear superior without explicitly omitting data.
Behavioral economics research highlights that investors themselves can be susceptible to cognitive biases, which might make them more vulnerable to cherry picking. For example, confirmation bias can lead investors to seek out and interpret information that confirms their existing beliefs about a promising investment, making them less likely to scrutinize potentially cherry-picked data.1 Despite the push for transparency and compliance, the psychological predisposition to trust seemingly successful narratives can still lead individuals to overlook red flags. Furthermore, while the Global Investment Performance Standards (GIPS) are comprehensive, compliance is voluntary for many firms outside certain jurisdictions or institutional mandates, creating gaps where less scrupulous practices might persist. The ongoing challenge lies in not just regulating disclosure, but also in enhancing financial literacy among investors to better identify and counteract such deceptive presentations.
Cherry Picking Performance vs. Survivorship Bias
While both "cherry picking performance" and "survivorship bias" can lead to a distorted view of investment returns, they represent distinct phenomena:
| Feature | Cherry Picking Performance | Survivorship Bias |
|---|---|---|
| Definition | Deliberately selecting and presenting only favorable results from a dataset, omitting unfavorable ones. | The tendency to only consider data from entities that have survived a selection process, overlooking those that failed or ceased to exist. |
| Nature of Distortion | Active manipulation or selective presentation of existing data. | Passive distortion due to the exclusion of failed entities from a sample. |
| Intent | Often intentional, aimed at misrepresentation to attract investors. | Typically unintentional, a statistical artifact when observing only successful outcomes. |
| Example | Showing only the best-performing years of a fund, or only profitable trades. | Calculating average fund returns by only including funds that are still active today, ignoring those that closed due to poor performance. |
| Focus | Performance over specific, chosen time periods or specific subsets of results. | The existence (survival) of the investment vehicle or strategy itself. |
Both biases lead to an inflated perception of investment performance and are significant concerns in portfolio management. Understanding their differences is crucial for investors conducting due diligence to ensure they are evaluating a complete and accurate historical record, free from both deliberate and unintentional distortions.
FAQs
Q: Why is cherry picking performance considered unethical?
A: Cherry picking performance is considered unethical because it deliberately misrepresents historical investment performance, creating an inflated and unrealistic expectation of future returns. It violates principles of transparency and fair dealing, potentially leading investors to make uninformed or suboptimal financial decision-making based on incomplete or misleading data.
Q: What are some common signs that performance data might be cherry-picked?
A: Common signs include presenting very short performance periods, showing only gross returns without corresponding net returns, lacking consistent historical data across different market conditions (bull and bear markets), focusing solely on a specific, small subset of investments rather than the overall portfolio management, or the absence of verification by independent third parties.
Q: How do regulators try to prevent cherry picking performance?
A: Regulators like the SEC and FINRA implement strict rules that govern how investment managers can advertise and communicate performance. These rules often require the presentation of standardized time periods (e.g., 1, 5, and 10 years), equal prominence for gross and net returns, and prohibit misleading statements or omissions of material facts. Industry standards like the Global Investment Performance Standards (GIPS) also provide ethical standards and guidelines for comprehensive financial reporting.
Q: Can cherry picking performance lead to financial losses for investors?
A: Yes, it can. If investors make decisions based on cherry-picked performance data, they might overestimate an investment's potential returns and underestimate its true risks. This can lead to inappropriate asset allocation decisions, investments in unsuitable products, and ultimately, financial losses that they were not prepared for, undermining investor confidence.