As seasoned investors we know from experience that Mr Market does not know or care who owns a stock or fund. The financial regulator obligates investment companies to make sure that the phrase ‘past performance is no guarantee to future returns’, appears on all investment product sales material when giving investors information on an investment manager’s past performance. However, does this help us? Several academic papers by Yale University and a study by Morningstar, the premier US fund research company, reveal that information relating to a manager’s past performance is at best misleading and at worst hazardous to an investor’s wealth!
To show fund performance in the best light possible, investment companies cleverly report figures on a ‘Time Weighted Basis’, which does not show the actual experience an investor receives for capital invested over a specific period of time. Investors examining published figures for top performing technology funds over the six-year period from 1997 to 2002, at the height of the technology boom and bust, would have seen an average return on +1.5% over that period. A superficial look at these time-linked results masks serious investor losses!
Studies from Yale University and Morningstar Research of investor flows in and out of technology funds during the ‘bubble’ of 2000 shows that they bought high when prices were rising and sold low when they were falling. With 1.3 billion US dollars invested on 1 January 1997, investments increased to a total of 12.3 billion over the six-year period committing a total of 13.7 billion dollars into the market. Net investment losses subsequently consumed 9.9 billion dollars of investor capital – 72%! Overly active managers chasing market returns gave investors huge tax liabilities of up to 20% adding insult to injury. Morningstar’s study further shows that in 17 categories of technology funds studied, the difference between the regulatory compliant published time-weighted returns with dollar-weighted returns over a 10-year period was a staggering 13.4% pa. Compound this loss over 10 years.
This empirical evidence shows not only the cynical way that investment managers report past performance but also the greed and emotion of investor behaviour. Generally, the majority of private and institutional investors follow the momentum of the herd, buying when prices are high and selling when prices are low. Sensible investors recognise that no one can successfully time the market although egos will tell them they can. Wise investors recognise that they are sitting across the table from a cynical well-honed ‘sales machine’ and make the necessary evaluation when information is presented. Just because an investment company is compliant with the regulator does not mean that the information is presented in the best interest of the investor. When corporate profit meets corporate ethics profit wins. Caveat emptor!
Jeremy Blatch TEP
This article was also published in the online and print editions of the Sur in English