The folly of fixating on three-year numbers
Returns from most major asset classes have disappointed in recent years, leaving many investors doubting their decisions.
Global equity (measured in rands) was the only asset class that gave a healthy margin above inflation over the past three years. But if you look at the longer-term picture, almost all asset classes beat inflation over almost all periods in the last 15 years.
“While it is understandable that investors feel unnerved, it is important to keep the longer term in mind before making any drastic changes,” said Anet Ahern, CEO of PSG Asset Management.
What’s wrong with worrying about three-year returns?
Firstly, for most investors who need capital growth, this time horizon is way too short. “Even at retirement we need to be thinking well beyond three years,” said Ahern.
Secondly, three-year returns are simply one point-to-point snapshot. Many investors choose funds based on historic three-year returns. However, the flaw in this assessment is that it extracts only two days from a naturally volatile market’s history. From that one number, investors must then try to assess the ability of a fund manager who should ideally be focused on making long-term decisions that will achieve returns above inflation.
“Even the most astute investor does not know with any precision when, or even how, these various investment theses will pay off; just that in combination, they have a good chance of doing so,” said Ahern. This makes an arbitrary three-year return number an imperfect starting point.
Thirdly, returns in growth assets are not smooth over shorter-term periods, and even a three-year number can vary greatly from one year to the next. “Fixating on shorter-term returns masks the powerful impact of compounding that a consistently applied strategy can deliver over time,” said Ahern.
Finally, these numbers are backward-looking and have no bearing on the investment opportunity currently available. We feel better when historic returns are high (even though the market may well be becoming expensive) and anxious when they are low (when in fact there may be great bargains to be bought that could generate excellent returns going forward).
“This is the biggest problem with putting too much score on historic three-year returns: they do not tell you whether the securities in a portfolio are trading at more or less than their true value, which is the most important determinant of future returns,” said Ahern.
Is there any use in looking at historic returns then?
When considered in context, over the right period and with the appropriate level of equanimity, you can use historic returns to evaluate your strategy and assess if you need to make any changes. It would be valuable to ask the following:
• Am I looking at the right time horizon for growth assets? It is unlikely to be three years.
• What have the asset classes done over this time? I.e. What was available for me to build my long-term investment strategy? Investments take place in a changing environment.
• Did I have enough diversification or should that part of my strategy be adjusted?
• Do I have enough invested in growth assets? The evidence favours long-term exposure to equities, preferably in a combination of local and global firms.
• Sure, cash looks great with hindsight. But is it practical and tax efficient to even think about being all in cash? How would I get the timing right to go back into growth assets?
• What did I miss out on and can I learn from this? An example would be government bonds, which have offered the opportunity to invest at 3% to 5% above inflation over the past few years, but were scorned by many investors because of sentiment.
Historic returns are just that
They have no bearing on investment opportunities going forward. “Even if historic numbers have disappointed, investors must uphold the principles of sufficient exposure to growth assets and a well-diversified strategy. These will be vindicated if applied consistently,” said Ahern.
