I just read James Cramer's Confessions of a Street Addict. It's basically his autobiography, and covers his career as first a broker for Goldman Sachs, and then a hedge fund manager from 1988-2000. Cramer has been highly visible for years as a Wall Street pundit, and on his Mad Money program on CNBC he is rather impressive in his ability to have an opinion on so many stocks. People ask questions on virtually any stock in the Wilshire 2000 and boom, he rattles off some insight that may be bad analysis, but right on the basic facts.

But nothing is so impressive as his hedge fund performance. He claims to have generated a 12 year track record with 24% annual return after fees. With an average hedge fund taking out 20% of the pnl, and traders taking out 10%, that would be an even higher 34%. Let's assume he and his traders didn't take the 10% trader bonus because he was not only the head trader, but the general partner. That implies a 30% average annual return for 12 years.

Now 30% is plausible, but he also states in the book he had only one down quarter. If we assume the probability of a down quarter is p, and he traded for 48 quarters (12x4), that means a maximum likelihood estimate for p of a mere 2.08%. If his 30% returns were normally distributed, one down quarter out of 48 is consistent with an annualized volatility of only 4.25%, for a Sharpe of 7.05 (using a simple Sharpe that ignores the risk free rate).

That has to be the best 12 year hedge fund performance ever. So high, it rings untrue. Warren Buffet's Berkshire Hathaway generated a measely Sharpe of about 1.1 over that period. The average of all Long/Short equity hedge fund returns, with survivorship bias, has only a 1.1 Sharpe from 1994 to 2005 (this is an upward bias of the average hedge fund sharpe, since the mean is the same but the volatility diversifies). Given he had some years up 65% and 45% (he mentions these anecdotally, not a complete list), and a maximum drawdown of -38%, it just does not square with a 4% annualized volatility. Sure markets have fat tails, but tails generally are not that fat. 4 standard deviation events are plausible in the real world, but not 8 standard deviations when we are talking about portfolios and quartely returns (daily for individual securities are another matter). I don't know how his charitable trust is doing (which he started once he left his hedge fund in 2000), but that data might be helpful in figuring out what's really going on. Perhaps he is not exaggerating, in which case, he is clearly silent on how he made most of his money. Merely being a good trader can't take you 7 standard deviations above a random walk.

I suspect there are at least three things going on. First, these are unaudited results, and he's exagerrating somewhat. Secondly, his strategy (which he describes pretty well, though he downplays this versus his fundamental analysis) of paying lots of money to brokers and getting and giving them lots of information, with only $300 million in capital, might generate some abnormal alpha. It's a unique strategy that probably worked well in the 1990's when broker upgrades and downgrades had more patent insider information--brokers would leak their recommendation changes to accounts generating lots of commissions. Lastly, he admits receiving lots of IPOs, and again, back in the 1990s that was pure arbitrage for anyone smart enough to understand the game. The quid quo pro is commissions to brokers for underpriced IPOs to the trader, all paid for by the issuer (because they only issue new stock once, and are afraid of challenging conventions). Again, with only $300 million in capital, a well executed IPO quid pro quo strategy might have been a viable and highly profitable strategy.

But he's clearly not telling near the whole truth when he says in interviews he mainly outperforms by using fundamental analysis.