Wednesday, 14 September 2011

Fund Performance Data Tables - How not to pick Investment Funds

If you want to find the price of an investment fund you don't have to look very far. You can very quickly get performance data for pretty much whatever time frame you like.

With investment funds there are many many factors to consider yet a great majority of people look solely at the league table. They see a snap shot of past performance and make decisions on future returns and therefore where to invest their money based on only a very simple and flawed metric.

I think it is pretty well established that past performance is no guide to the future and the price of a fund and go down as well as up, and you may get back less than you invested No doubt you have seen something like this very very often. I couldn't imagine how many times I have written (copy and pasted) that in the last 10 years...

In addition we should also know that the price of units in the short term is volatile and nothing more than a reflection of a collective snap agreement on the price of a fund. Read my article on majority rules.

We talk about volatility in the short term however in reality volatility does not decrease the longer you have been invested; what does happen is that if your investment portfolio has increased in value then the effect of short term volatility has a reduced impact on your overall portfolio value.

A 10% fall in the market will no doubt feel much worse the day after you invested than years later (assuming the portfolio has grown in value) when the impact of the 10% reduction effects only previous growth, not your original capital.

So as almost all investors will have heard from their advisers, "sit tight as investing has to be a long term strategy". That said it is difficult not to take an interest in "the league table" to see where your investments are relative to all the others.

You may have heard stories about investment competitions between a professional money manager and a school girl: inevitably after 6 months the school girl outperformed the professional (remember of course that a folklore story carries much more credence if the outcome goes against the expected outcome). If the exercise was repeated lets say 100 times I wonder how often the school girl would win???

I have also heard many times things like, "only 1% of the top 100 performing unit trusts today will be in the top 100 in 3 or 5 years time..."

So short term volatility is to be avoided but then the best performing funds today will not be the best tomorrow. I was curious so about 6 months ago I decided to do some research of my own to see if and how badly misleading this stock table performance data can be.

I used performance data from www.trustnet.com published in Professional Adviser each week. From February 2011 I noted the top 20 performing investments based on their 3 year performance record.

Each week I noted the prices of the then current top 20 and also any members of previous top 20 funds so obviously as the weeks passed the list of funds which had once been top 20 increased - A LOT!!

Over 6 to 7 months of collecting the weekly data there emerged some interesting facts, for example:

  • Only 4 funds remained in the top 20 over the entire period &
  • The list of funds which had been in the top 20 ran to over 50
I then wondered, had I invested money in THE top 20 performing funds in February based on their three year performance what would have happened to my portfolio to date.

The average return on February's top 20 at that point over 3 years averaged 79.6% That means an investment of £10,000 in those funds in February 2008 would in February 2011 be worth just under £18,000 approximately, certainly not to be sniffed at in only 3 years!!!!! Great, I am in...

In the 7 months since then how have those funds performed?  MINUS 8.53%





www.trustnet.com 13th September 2011

I appreciate we have had some pretty torrid times on the stock market in the last 6 months but only 4 of the top 20 are still there 6 months later!! which I could  You looked at 3 year performance data and selected the 20 best performing funds over that period and after 6 months are down nearly 10%...

Out of interest the top 20 funds over 6 months as at 13th September 2011 returned on average 15.2% so still very reasonable given the market conditions...

The top 20 funds over 3 years as at 13th September 2011 returned on average 91.8%. 12% higher than the top 20 of 7 months earlier... The current 3 year top 20 is dominated by the returns on gold - 3 year average 162% but in the last 6 months these same funds have returned only 5.1%. The returns on Gold have not therefore happened in the last 6 months but rather before this period. I would suggest that maybe buying into Gold based funds now is a little after the event; possibly these funds will now under perform... It really is just a guess so please don't base your investment decisions on what I say...

Only 4 of the funds in the 3 year top 20 in February 2011 are still in the top 20 in today (2 of which are in positions 1 and 2) however, 7 of the previous top 20, over a third, are not even in the 3 year top 100!!

There are many things to draw in conclusion of this data but the main one is, as I eluded to before, PAST PERFORMANCE REALLY IS NO INDICATOR OF FUTURE RETURNS.

So what should you do?
  1. Undertake research into the underlying metrics of each fund in the market, there are nearly 3,000 to go through so good luck with that one!!
  2. Through your financial adviser (or direct) employ the services of a discretionary fund manager (DFM) whom with research teams and experience does stand a better chance than many of making the right decisions at the right time, when and what to buy and sell. Unlike financial advisers who plan your financial lives a DFM looks almost solely at the money management side of things so the two working together can be a great combination.
  3. This is the clever one, instead of trying to pick certain funds and make timing decisions about when to buy and when to sell, change your own philosophy on investing. Prices will rise and prices will fall, accept it, but not investing is the only sure fire way to miss out on company growth (the underlying thing which determines long term fund value). If you buy a fund the strong likelihood is that it will not be one of the top performers, again you should accept that but through the right asset class strategy and the help of a firm such as Dimensional or Vanguard along with your financial adviser you may find a strategy which works for you; a long term broad mix strategy which avoids fad investing and top 20 lists and relies more upon basic investment principles. Speak to your adviser about this approach if you want more details.
I hope you have found this useful. If you have any comments, questions or points to make please get in touch or add them below...

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