Gross and Net Exposure Accounting

Gross exposure is the sum of the absolute value of every position, divided by net asset value; net exposure is the sum of signed positions, divided by the same. Both definitions look immune to error, they're just a ratio. The part that quietly breaks a backtest is the denominator: NAV changes every day as the book gains or loses money, and a simulation that computes position sizes off a starting capital figure instead of current NAV reports an exposure ratio that drifts from the number the strategy actually intended to run, in a direction that gets worse exactly when it matters most.

Worked example: 160% gross that becomes 200% after a drawdown, silently

A 130/30 long-short book is designed to run at 160% gross (130% long, 30% short) at all times, rebalanced against current NAV. A backtest bug instead sizes every position off the account's starting capital of $100 million, fixed for the whole simulation, rather than the NAV as of each rebalance.

The bug doesn't announce itself, gross notional in dollar terms looks perfectly stable across the drawdown, which is exactly why it's easy to miss on a quick check. But measured the way a risk desk actually measures it, against current NAV, the book has silently levered up from 160% to 200% at the worst possible time, right after losing a fifth of its capital, because the position-sizing logic never re-based off the number that had actually changed.

The check is simple and worth automating: at every rebalance, recompute gross and net exposure directly from current position values divided by current NAV, and assert the result stays within the intended band, never trust a dollar-notional figure alone as a proxy for exposure.