The perils of past performance
Thereis no shortage of research, both anecdotal and academic, which states that past performance is a mixed blessing but any pursuit of it is bound to fail.
MorningstarandVanguard Investmentsconducted research last year which found that this year’s leading retail share funds are most times next year’s followers.
According to the data, only 16 per cent of funds among the top five performers in one year duplicated this the year after, based on analysis of the five top performing retail Australian share funds each year from 1994 through to 2003, which compared each year’s performance with the subsequent 12 month period.
In fact, the average slump in the following year for the five leading funds was 15 per cent. In terms of numbers the funds outperformed the S&P/ASX300 Accumulation Index by an average of 16.6 per cent when they were rated in the top five, but then only marginally beat the index the next year by 0.3 per cent. The next year after that only half the top performers matched the index.
And while these numbers give a local feel to the past performance issue,Brillient!’sDiedre Keown says more than 100 studies have been conducted in the UK, USA and Australia over four decades into this question, resulting in a number of key conclusions.
According to Keown, it has been found that bad past performance increased the probability of bad future performance but there was no correlation between good past and good future performance.
Where there was performance persistency, it was more frequently in the shorter-term, that is, one to two years and the outperformance margin tended to be small.
Lastly, returns were only meaningful if adjusted for risk/volatility and comparing similar types of funds.
Keown says what sticks out is the issue of performance persistency over the short-term, mainly because the financial services industry has encouraged investors to ignore short-term performance, and focus on the long-term, despite evidence that suggests short-term relative performance is relevant to picking funds, more so than long-term relative performance.
This is backed up by research from 2002 which used both raw and risk-adjusted returns on equity funds and found a pattern which reflected that shorter-term risk-adjusted returns correlated with shorter-term future performance; and medium to long-term risk-adjusted returns correlated (weakly) with medium to long-term performance.
So instead of looking back at only a single year equity fund, investors should use two years of data to help paint a picture of up to two years into the future, and at least three years of past returns if looking at a three year investment — but the two year prediction is the more robust.
AUTHOR
Jason Spits
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