This article was originally published August 2017
Nothing Compares 2 U is a great song. Most people will know the Sinead O’Connor version from 1990, and some will be aware that Prince wrote it and performed it live. But most people have never heard the original version from 1985 (which Prince didn’t sing).
Given three versions of the same song, you can easily compare and make a personal judgement on the best version. But judging songs, like any art, is very subjective and our judgement comes loaded with personal biases we may or may not be aware of.
Judging investments can be the same, despite there being more science to it, because there are numbers involved. But our biases are usually the same — we look for “good” numbers and judge on them alone.
Past performance warning
All discussions about the past performance of any investment should carry the following warning:
past performance is not a reliable indicator of future performance.
While it is an important concept, the following addendum does help expand the concept:
short-term past performance is a really unreliable indicator, but long-term past performance does give a pretty good idea of future “relative” performance.
Comparison and regret
It is human nature to compare things, and in the current age of almost infinite access to information, we are set up to be disappointed more often than not. How much do I weigh compared to the average Australian? Is my income better than average? How much money should I have at this stage of life? Do I work more hours than another person doing the same job? How does my “happiness” compare to others?
How did it do over the last year?
In the investment world, this is THE most asked question. It is inescapable! And the effort that goes into reporting and explaining short-term performance is such a huge waste of energy, but must be done because we all want to know if and why an investment did better or worse than some benchmark.
But this means we lose sight of the original warning — short-term performance is a terrible indicator of the future.
What if we weren’t told the short-term performance?
The following table shows a selection of Australian and International share funds. Each fund is actively managed (it doesn’t seek to just replicate an index) and all the funds operate in a different manner (some have very concentrated portfolios, some focus on income over growth, some favour smaller companies as opposed to “blue chip” businesses).
These figures tells us nothing about the real quality or skill of the managers, and the disparity of returns is large, especially in the Australian funds. Funds A and D have had a cracking 3 months, but their 1 year numbers are poor in comparison to the index. Fund B was outstanding in both absolute and relative performances over 1 year, but are returns that good, too good to be true in the future? In the international space, there were fewer disappointments with only one fund under the index for 1 year, though Fund I looks like a terrible performer at half the index return.
Now let’s forget about the short-term and focus on a proper and more valid investment time frame of at least 3 years.
Fund G has been running for slightly under 3 years.
While there is still some disparity in absolute and relative (to the index) returns, the range of returns is tightening. I think most investors would be happy with any of those returns, or the average of them all, over the long-term.
What the return figures don’t tell us
What cannot be determined from just the return figures is the risk taken and what has happened during sharp market downturns. Some interesting points about some of the funds:
- Fund B had a period of substantial under-performance, followed very quickly by a year where the return was almost 3 times the index. This fund is not for the faint-hearted!
- Fund D does not invest in any top 20 companies, which makes its composition very different to the Australian market, where the top 20 make up 55% of the ASX200.
- Fund G has short positions on specific stocks and is the most active with currency management. In theory, this funds should be better positioned to weather tougher markets. While the fund is only new (under 3 years of performance figures), the team running the fund has been together and successfully running a similar fund for over 15 years.
- Funds E and I, which have returned the lowest in the sample, are the most conservative funds and on average have only taken around 60%-70% of the risk of Funds C, D, F and H. Lower risk equals lower return, which is fine.
The moral of the story…
Discussing and comparing short-term numbers is pointless, yet it’s impossible not to do exactly that because this is what we’ve been conditioned to do. We just need to keep reminding ourselves that investing is a long-term game and in the end, much of what we get will be determined by broad market movements which are out of our control.
This article is the opinion of the writer and does not consider the circumstances of any individual. This document has been prepared by Peter Keogh (Authorised Representative No. 253538 of Paragem Pty Ltd AFSL 297276) and is intended to be a general overview of the subject matter. The document is not intended to be comprehensive and should not be relied upon as such. We have not taken into account the individual objectives or circumstances of any person. Legal, financial and other professional advice should be sought prior to applying the information contained in this document. No responsibility is accepted by Peter Keogh, Paragem or its officers.