Rank­ings don’t equal re­turns

In­vestors need to know what strat­egy they’re buy­ing

Finweek English Edition - - MONEY CLINIC -

I’M OF­TEN ASKED: How do you use fund rank­ings? It took me some re­search just to deal with the an­swer su­per­fi­cially. The an­swers are con­fus­ing or too touchy feely for my lik­ing. Yet there are usu­ally some hard facts be­hind rank­ings that also give some com­fort. They may be a fine in­di­ca­tor of core com­pe­ten­cies: but then again, you need to find out what de­liv­ered the per­for­mance that earned the rat­ing. Bot­tom line is that you shouldn’t be buy­ing or sell­ing a fund on a rank­ing: it’s much more im­por­tant to un­der­stand the in­vest­ment strat­egy of the man­ager and its fu­ture prospects of suc­cess.

The first and ob­vi­ous prob­lem with rank­ings is they re­fer to past per­for­mance, which may or may not be a rel­e­vant in­di­ca­tor of fu­ture per­for­mance. Why? Well, af­ter in­vest­ing a few years on, fund man­agers and strate­gies some­times change – and mar­kets def­i­nitely change – im­prov­ing or re­duc­ing re­turns. How much of what worked be­fore is still valid? It’s not al­ways easy to get clear an­swers, al­though a per­sis­tent ad­viser might be able to achieve the nec­es­sary.

The next ques­tion is how much of past re­turns were based on good, old fash­ioned in­dex match­ing – and how much came from stock se­lec­tion, al­lo­ca­tion and tim­ing? Yes, how­ever loud the de­nials about the fea­si­bil­ity of mar­ket tim­ing, the in­dus­try does it with a lot of suc­cess (and some mis­er­able fail­ures). They just la­bel it se­lec­tion or al­lo­ca­tion – or may even call it “find­ing value or growth suc­cess­fully”. A high risk-ad­justed re­turn rank­ing may in­di­cate some con­sis­tency in those skills, be­cause a typ­i­cal rank­ing cal­cu­la­tion usu­ally cov­ers a rep­re­sen­ta­tive pe­riod such as three or five years. But a low rank­ing won’t nec­es­sar­ily in­di­cate the op­po­site.

But the en­quiry doesn’t end there. How did the strat­egy for the pe­riod cov­ered by the rank­ing make the re­turns? Did the fund do best in a bullish or bear­ish phase of the mar­ket? Some funds thrive in volatil­ity be­cause they have the in-house skills to make re­turns from short-term moves. Other funds suf­fer.

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