In­vest­ing on past re­turns

Finweek English Edition - - MONEY - Su­pe­rior rel­a­tive past per­for­mance may in­di­cate in­fe­rior fu­ture re­turns. Ev­ery as­set has an i ntrin­sic l ong- term re­turn Look at the past re­turns over many dif­fer­ent pe­ri­ods.

All prod­ucts come with a warn­ing that past re­turns are not an in­di­ca­tion of fu­ture re­turns. How­ever, it is even more dan­ger­ous than that –

– a sus­tain­able re­turn given the level of risk that in­vestors are will­ing to take in that as­set. From time to time, due to spe­cific cir­cum­stances, in­vest­ments can pro­vide above av­er­age re­turns, even for a pro­longed du­ra­tion. Take as an ex­am­ple, the re­turns achieved by prop­erty over the past decade – in­vestors re­ceived in ex­cess of 20% per year, even bet­ter than eq­uity in­vestors did. There were very spe­cific rea­sons, such as the sys­tem­atic de­cline in in­ter­est rates (there were many other fac­tors as well). The long-term av­er­age re­turn for prop­erty is closer to 10% per year.

If you now look at the past re­turns of prop­erty, you would be tempted to jump in. How­ever, it is likely that the fu­ture re­turns might be be­low av­er­age – the con­di­tions that fu­elled the re­turns are no longer present. The same ap­plied to IT shares at the end of the Nineties l ead­ing up to the 2000s, or con­struc­tion shares in the run-up to the 2010 FIFA World Cup.

Prod­uct providers are guilty of us­ing su­pe­rior past re­turns to pro­mote their prod­ucts, right at the peak of the in­vest­ment cy­cle. It makes for en­tic­ing bill­boards! Do not fall for this. By the time a re­turn is wor­thy of bill­boards, be wary.

Study the three-, five- and 10-year re­turns and then the in­di­vid­ual an­nual re­turns at dif­fer­ent times to get a bet­ter un­der­stand­ing of the po­ten­tial re­turns and risk. If asked, most as­set man­agers and fi­nan­cial ad­vis­ers will pro­vide their es­ti­ma­tions of a long-term av­er­age ex­pected re­turn, which is a bet­ter hur­dle ex­pec­ta­tion.

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