Past performance? You must be kidding
Time and again stock market investors are warned that past performance is no guide to the future. This admonition has been a feature of financial product marketing for more than 30 years. And you would think it was a cornerstone of guidance and advice given to investors in the obligatory Key Information Documents (KIDS).
Yet the KIDS have come under fire for giving “actively misleading” guidance based on the use of past performance as the basis for future projections. The Association of Investment Companies, the trade body for the investment trust sector, has called for the suspension of “actively misleading” KIDS and urged the Treasury to launch an inquiry.
The association says its latest research “demonstrates conclusively” that KIDS are systematically flawed as they rely on past performance as a basis for future projections.
The trade body has previously refused to publish the “utterly misleading” KIDS on its website, with Sayers saying he heard people dismiss KIDS as “not worth the paper they are printed on”. The latest report – Burn before reading – refers to the comments of Scottish Mortgage nonexecutive director John Kay that investors should “burn” KIDS rather than read them.
In the report, the AIC argued that estimated performance figures were “wildly optimistic” due to recent market movements. It found 11 per cent of investment company KIDS indicated that, in “moderate” market conditions, investors might expect annual returns of more than 20 per cent over the recommended holding period. Half (51 per cent) of KIDS, meanwhile implied annual returns between 0 per cent and 10 per cent in “unfavourable markets”. Another tenth (11 per cent) estimated annual returns of between 10 per cent and 20 per cent in unfavourable markets.
The AIC modelled 22 moderate performance scenarios, comparing this with the actual return an investor would have received had they held the investment for five years. For half of these periods – 11 out of 22 – the KID indicated the opposite, an investment gain, of the actual outcome, a loss. The AIC said such misleading scenarios, unbeknown to investors, could encourage them to buy high and sell low.
AIC chief executive Ian Sayers warned: “Telling investors that they can have high returns at medium-low risk in unfavourable markets is particularly toxic and entirely divorced from reality.”
Quite right. However, in the real world it is almost impossible not to consider an investment without even a cursory look at how it has performed in the past. And there is barely an item of overall investment commentary that does not draw on past performance to opine on where markets might go from here.
Consider, for example, a press release sent last week by the AIC itself to mark the tenth anniversary of the collapse of investment bank Lehman Brothers. It looked back on how investment trusts have performed in previous downturns and bear markets. This is particularly germane now after US and UK stock markets have enjoyed a remarkable ten-year bull market run and there is apprehension that a setback looks likely.
“It’s useful,”it began, “to revisit the past.” Hmmm. After the dot-com bubble burst in March 2000, the FTSE 100 suffered a sharp decline. But, the AIC asks us to consider, a £1,000 investment in the average investment company at the beginning of March 2000, just before the downturn, would have recovered and grown to an impressive £4,350 at the end of August 2018, a gain of 335 per cent.
“Whilst 18 and a half years is a long time,” it argues, “it includes a recovery from both the dot-com crash and the global financial crisis and is an example of the benefits of long-term investing, particularly when the original £1,000 investment would have initially fallen to £660 in October 2002 before recovering.”
It also cites the example of the global financial crisis of 2007-9 – a period of market turmoil and a major economic downturn. A £1,000 investment in the average investment company at the beginning of October 2007, when markets were near their highest before the crash began, would now be worth £2,470 (end August 2018), a 147 per cent increase almost 11 years later.
The article underscores the wisdom that it’s “time in the market, not timing the market” that really matters and which holds true.
But there is another implication: that, on past performance, the average investment trust can ride out market downturns and holders can come out with stunning profits.
True, over chosen periods. But we cannot be at all sure that a future downturn the market will conform to previous such periods. But here’s another chosen period to ponder, useful as a memo item: it took Wall Street 25 years to recover to the 1929 pre-crash level. “Time in the market” indeed. But 25 years is rarely a private investor’s chosen timespan.