‘Live by performance, die by performance’. Dr Benjamin Holdsworth explains why investors should not run after star funds.
On any piece of investment literature the warning ‘past performance is not a guide to future performance’ is always prominent, in bold, and 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. Funds 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 do.
Deep down in the investor’s psyche lurks a little demon that wants to get rich quick, suffers terrible pangs of FOMO (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 as they clatter down the track.
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 stocks, that happens to be in favour.
Markets make managers. This is combined with the recency bias gremlin that also lurks in our psyche, which places more weight on more recent experiences than on those that occurred further in the past.
This is then 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 that past performance does not tend to persist. This is clearly demonstrated by data and research going back decades.
Examining 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 of over 214% from the start of 2020, in US dollar terms, to its peak on 12 February 2021.
Its chief executive Cathy Woods was a regular on US business TV shows, spawning an almost cult-like following. It hit a unit price high of $157 – up from US$50 on 1 Jan 2020 – but has since then plummeted to US$37, losing 76 % of its value (to 12 May 2022).
ARK’s return is now almost exactly in line with the broad US equity market for those invested over the entire period.
As the saying goes, ‘if you live by performance, you die by performance’. It is worth remembering that the worst fall ever in the UK equity market since 1900 was of a comparable magnitude to ARK’s (-73%) in 1973-4.
Unfortunately, performance- chasing investors tend to come to the game late. Net flows into the ARK fund peaked at the start of 2021, just as performance peaked. Assets gathered from investors in 2020 and 2021 represented around 90% of all net inflows since the fund’s inception in 2015. Bad timing is never good news.
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 is 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 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: ‘Past performance is not a guide to future performance’.
Dr Benjamin Holdsworth (right) is a director of Cavendish Medical, specialist financial planners helping consultants in private practice and the NHS
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