Why past performance is no guarantee of future performance

Henko Roos, Head of Manager Research at PSG Wealth
Henko Roos, Head of Manager Research at PSG Wealth

“Past performance is no guarantee of future performance,” has become an axiom of the investment industry. Yet too often, novice investors use positive returns in one financial year as a harbinger of anticipated growth for the next. The constant cycle of chasing past wins is a volatile one that does not account for a myriad of other factors, which influence investment outcomes.

This is according to Henko Roos, Head of Manager Research at PSG Wealth, who points to research that the company conducted comparing the performance of funds with the Association for Savings and Investment South Africa (ASISA) Multi-Asset Low Equity sector. The research juxtaposes fund performance for one year (ending March 2020) with performance during the next year (ending March 2021). “Our research shows that the top-performing funds from 2020, under-performed in 2021 – with the inverse also being true.

“The take-out? Last year’s winners often become this year’s losers.”

Roos says that even seasoned investors often fall into the trap of making decisions based primarily on past performance, yet this is somewhat short-sighted. “By ‘performance chasing,’ investors buy at the top of the market and sell at the bottom – which erodes value over time.”

‘Performance chasing’ is used to describe instances where investors opt for top-performing funds without considering other determining factors. “It is risky because long-term returns are negatively impacted when investors jump from one product to the next. Investors who do this stand the risk of purchasing overinflated assets. When the relevant asset class falls back to being fairly valued, investors can realise a permanent and irrecoverable loss,” he explains.

Roos says that past performance is just one consideration in how a fund will fare and should not form the sole basis of an investment decision. “For example, a portfolio’s turnover needs to be considered – high turnover could result in excess taxes and related fees. The cost of changing the structure of a portfolio is also something to be examined. Market timing is also key, as choosing stocks based on news headlines or current affairs rarely leads to highly favourable results in the long run, so investors should weigh up their short-term versus long-term goals. Risk is another key factor, which also needs to be accounted for, and while some risks can be controlled, others cannot.

“Due to the number of investment options available to investors, it is a far more layered process, and there are a number of factors that should be taken into account. These include, among others, macroeconomic indicators, market dynamics and aspects like assessing the parent company, the people managing the fund, the pricing of the portfolio, and the process and philosophy followed.”

Roos says that when looking at the potential of an investment, it’s important to look at it in the context of the portfolio as a whole and how the behaviour of different stocks affect the financial outlook of the investor. “As the report advises, diversification remains an unconditional requirement to successful long-term investment. We, therefore, encourage investors to use multi-asset funds that actively allocate across a wide range of asset classes, both locally and abroad.”

He believes that the key to not falling prey to an over-simplified way of approaching investment is to consult an experienced financial adviser, who will assist investors in constructing a sound financial plan based on a comprehensive analysis that takes all contributing factors into account.

“At PSG Wealth, our teams construct solutions that are not just diversified across asset classes and sectors – but also geographically and across different investment styles and philosophies. Our fund managers play a key role in guiding investors, helping them steer clear of the potential pitfalls that lie in making a decision too heavily weighted on past performance.

“Our solutions are designed to experience lower drawdowns while still participating in the upside, to incrementally provide consistent alpha. This creates a smoother ride for the investor, who is then less likely to experience the angst that is often part and parcel of a more volatile outlook, which often results in one wanting to leave their existing product in exchange for past winners,” says Roos.

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