'Double the market!' and how statistics can lie
With these three tricks, fund managers and advisors can easily misrepresent their performance. Don't be fooled.
I read a portfolio report recently with a catchy opening line - 'We've doubled the market!'. A nice graph was presented showing that, indeed, the portfolio in question had doubled the return of the S&P/ASX All Ordinaries Index over the past few years. Unfortunately, the comparison was as useful as saying you beat Tiger Woods in an archery contest.
The average annual return of almost 10% was decent. One could argue, then, that it's unnecessary - or even unsportsmanlike - to nitpick about how the manager earned that return and presented the results. Surely what matters is the actual return achieved.
I don't think that's right. Especially when every day the media uncovers a new financial services betrayal, trust in fund managers and advisors is evaporating, and 'Royal Commission' is a household phrase. It's more important than ever for performance figures - good and bad - to be accurately represented and free of marketing spin.
Unfortunately, stretching the truth in the presentation of investment results is common, so here are three of the most popular tricks to watch for:
Bad benchmarks. The trick favoured by the 'market doubling' manager mentioned above was picking an unrepresentative benchmark, the All Ordinaries Index, which is composed of Australian companies. Their fund, on the other hand, has supplemented its investments in Australian stocks with an assortment of international stocks and ETFs. It's bonkers to compare a worldwide collection of stocks to the return of the small Australian market, not least because it introduces currency effects. You might think that managers are legally required to choose a benchmark that reflects their strategy and holdings, but this isn't the case. Check that your fund manager or advisor has chosen an index that matches their pool of potential investments, otherwise they may be trying to shift your attention. For more on the importance of benchmarks, see Avoid any fund manager that says this...
Short time periods. It's natural that a manager or advisor will talk about their quarterly or yearly returns because this is the industry convention. But that doesn't mean those numbers are useful in judging their skill as a manager. For one thing, good short-term performance could be hiding a poor long-term record - if you get mail from a manager at random times of the year promoting their funds, it's possibly because the fund did poorly exactly 13 months ago and that period has now 'rolled off' the comparison chart. Other time period tricks are to annualise a return that's shorter than one year or to fail to mention that a return is a total compounded return spanning several years, both of which would make the result look bigger. It's better to look at long-term track records - the longer the better - where a manager's skill won't be drowned out by the market's short-term volatility and periods of underperformance aren't so easily hidden. For the record, Intelligent Investor's own stock recommendations have delivered an average annual return of 14.3% and beat the S&P/ASX 200 by 5.2% a year since 2001.
Survivorship bias. When funds do poorly for an extended period, they tend to be closed and their details removed from a manager's website. The funds you see today are the survivors. However, this can give you a biased view of the manager's performance because you only get to see their successes. All managers have periods of underperformance; it's inevitable. Acclaimed value investor Peter Lynch even said: 'If you're terrific in this business, you're right 6 out of 10'.
If you see a manager presenting extreme results, it's probably a sign that something isn't right. Check the benchmark and time period, and ask for a complete historical list of funds and recommendations before investing to check that they aren't sweeping any bad runs under the rug. You can see an audited list of performance figures for every recommendation Intelligent Investor has ever made here, while the performance of our sister company InvestSMART's funds are detailed here.
If you're an investor, you've probably read ad nauseum by now that 'past performance does not guarantee future results'. Remember, though, it's not just the future that's unclear - past results can be just as blurry.
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