Pryor Cashman clients Marc S. Freed and Lyster Watson & Company (Lyster Watson) were issued a patent on April 27, 2010 on their True Alpha method of ranking financial fund performance. Patents on business methods are difficult to obtain and the patent, U.S. Patent No. 7,707,092, was issued after over five years of proceedings before the Patent Office, including multiple rounds of arguments and the submissions of substantial amounts of evidence in support of patentability. In addition, the Patent Office provided a patent term extension for the period of exclusivity (normally 20 years from the date of filing the application) for an additional 1,151 days.

Pryor Cashman Partner Andrew S. Langsam, Chair of the firm’s Patent Practice and a member of the Intellectual Property Group, handled the application and its successful prosecution for Freed and Lyster Watson.

The invention is entitled “System and Method for Ranking Investment Performance.” True Alpha is a sophisticated method of ranking the performances of each of a set of investment funds by (a) taking into account each fund’s Return on Investment over a given period of time and the Volatility or Standard Deviation of the Fund's Return over a longer period of Time, and (b) comparing those results to an average Market Rate of Return.

True Alpha is distinct from other Fund Performance Rankings (which also use Rate of Return and Volatility) because True Alpha takes into account what Return on Investment was available to the Fund and factors into the Fund’s performance whether the Fund's investment strategy leveraged or maximized the Fund’s Rate of Return and, if so, whether it did so by needless or reasonable exposure of the Return to losses.

For a more detailed explanation of the patent and the True Alpha method, please continue reading.

Financial funds often simply report their results based on their Return on Investment over a given period of time. Some provide the volatility (or standard deviation) of the Return on Investment over an even longer period of time so that investors can determine the short and long term Return and the relationship of the Returns to the volatility of the Return. Traditionally, those two factors are graphically plotted and referred to as the Sharpe Ratio (Return on Investment as a function of Volatility) in comparison to the general market performance or in comparison to similarly situated, modeled or managed funds, one end tethered at the rate of return of a substantially risk-free investment where the Return on Investment is substantially riskless and thus volatility is substantially zero and the other end of the line passing through the overall market’s rate of return as a function of overall volatility.

Traditionally, those individual funds that simply exceed the return on investment of the market or another fund are considered superior investments and those which lie below the market line are considered relative inferior investments.

Freed and Lyster Watson’s now patented True Alpha methodology of ranking relative fund performance is far more elegant and provides more meaningful data and ranking. True Alpha takes into account an additional factor, namely, whether or not the fund’s management has taken maximum advantage of what investment opportunities were available to the market while minimizing risk.

Geometrically, the Lyster Watson True Alpha patented method first calculates and then ranks the orthogonal index scores (OIS) or the distance of each of the fund’s datapoint (Return as a function of volatility) from the Market Line. This can be done in a variety of ways but preferably by using Orthogonal Indices, i.e., theoretical points on the Market Line through which a perpendicular passes which also passes through that fund’s Return as a function of Volatility datapoint. The greater the arithmetic distance of the fund’s performance from the Market (all positive values are superior to any negative distance, even one of greater magnitude) the superior that fund’s financial performance.

A fund with only a slightly greater Return on Investment to another fund will not have a better ranking if the latter less profitable fund is less volatile while a fund with a smaller volatility than another fund may not have been the best investment if the Return on Investment of the more volatile fund far exceeds that of the less volatile fund. Thus, the distance the fund extends from the Market is determinative of the ranking of the funds. Those with the greatest arithmetic distance took advantage of market opportunities while those with lesser relative distances may not have or, if they did maximize their Returns on Investment they did so with excessive relative risk.

When all of the funds under consideration are compared and ranked, an investor understands which fund really can claim to have had superior performance – maximizing what the market had available for the time while minimizing exposure to risk over time.