Financial theory says something quite radical, i.e. that the only real investment decision an investor faces is how much risk to take. So we started from that vantage point. For the fund, we chose the level of risk of an S&P 500 index fund because we felt that would be familiar to people. We then back tested and simulated a model of our fund at an annualized, daily standard deviation of 16%.
To carry out a proper back test, you can’t look at history in the order events as they happen. Because it is a random walk; you have to do it over and over again, in a different order. In this process, we predicted we could achieve excess returns of at least 400 basis points per year; and If you look at the last 20 years, this has turned out to be the case. Our model turned out to be right: The S&P 500 has produced a total return of 7.2% a year in nearly twenty years, and we have produced 14.8%.