News & Views

Live by performance, die by performance

On any piece of investment literature, the warning ‘Past performance is not a guide to future performance is always prominent, in bold, and is generally glossed over by most readers.

Yet all actively managed funds are sold specifically on their ‘great’ past performance, usually by comparison to a ranking against their peers or a market benchmark. Those that perform poorly never get to see the light of day in adverts or best-buy lists.

Many investors would be well advised to take heed of this warning. Those investing in a systematic way, seeking to capture market returns for market risks taken on, certainly take heed of this warning.

Deep down in the investor psyche lurks a little demon that wants to get rich quick, suffers terrible pangs of FOMO or fear of missing out and becomes blinded by the urge to jump on the runaway train of rampant performance despite the warning signs that flash in front of their eyes, as they clatter down the track – you know the warnings, ‘Past performance is not a guide to future performance…past performance is not a guide to future performance.

We know too, from experience, that often funds that outperform over the shorter term are riding an investment style train, such as technology companies or growth companies, that happens to be in favour.

Markets make managers. Combined with placing more weight on more recent experiences than those that occurred in the past, and exacerbated by the fact that most investors get excited and invest only after much of the stellar performance has been delivered, one can spot the coming train wreck.

The harsh reality is, the past performance of managers of actively managed funds, does not tend to persist.

Many studies reveal that top performing managers in one period end up scattered randomly, as expected by chance, over the subsequent period. Taking a look at one of the funds that hit the headlines in 2020/21 with its stellar performance provides a sobering insight into the dangers of chasing performance.

ARK Innovation, a highly concentrated, high risk, ‘disruptive innovation’ technology fund, had a stellar rise from the start of 2020, in US dollar terms, to its peak in February 2021. Its CEO Cathy Woods was a regular on US business TV shows, spawning an almost cult-like following yet by 12th May 2022, the fund has since lost 76% of its value – its return is now almost exactly in line with the broad US equity market for those invested over the entire period.

The truth is, if you live by performance, you die by performance.

It is also worth remembering that the worst fall in the UK equity market since 1900 was of a comparable magnitude which saw a fall of 73% in 1973/74.

Unfortunately, performance chasing investors tend to come to the game late when it comes to these funds, with market beating performance. Net inflows into these funds can often peak, just as performance peaks and furthermore, assets gathered from investors can often represent the majority of all net inflows since a fund’s inception. This is not good news.

With the ARK Innovation fund, it is evident that most investors failed to capture the strong upswing, piling in at the top and suffering the subsequent calamitous downturn.

The average investor’s return is likely to be materially worse than the fund’s return, on account of this poor timing, although no exact data are yet available.

Investing is a hard enough emotional challenge at the best of times.

Chasing performance just adds to the complexity and stress involved and may well put long-term investment goals at risk. Taking specific risk on such a fund is simply a gamble.

Next time you read a product factsheet or see an advert for a fund in the paper avoid the siren calls of stellar performance and take a moment to reflect on the free, sensible, and seemingly boring advice it is obliged to provide, that, ‘Past performance is not a guide to future performance.

At Wells Gibson we don’t chase performance, we design Wealth Plans so you can secure all that you value.