Going forward whilst looking backwards
As a Financial Advisor I am often asked to give my predictions on what is going to happen in the future. What will the Rand Dollar Exchange be in 6 months’ time? Will markets continue going up? and which share or fund will be the best performer over 6 months, 1 year, 10 years? Are questions that I am often asked.
Clients, friends, and family are then distinctly unimpressed when I answer that I have absolutely no idea. I can tell them whether an asset is cheap or expensive relative to certain performance matrixes. I can also tell them that markets, exchange rates etc will go up down and sideways in future, but probably not in that order. The problem is that with most things in life we cannot say with any degree of certainty what is going to happen over any specific time frame.
I will often get confronted with the fact “this fund has performed extremely well over the last 6 months, 1 year or 10 years”, the fact of the matter is that choosing a fund based on past performance is like trying to drive your car whilst only looking through the rear-view mirror. Past performance especially short term past performance is a very poor indicator of future performance.
Funds P and N in the table below are two of the funds that we have used for quite a while in the low equity space. Despite the fact that it has 3rd quartile performance when measured over the last seven years, fund P was a stellar performer (predominantly first Quartile) right up until the end of 2017. Fund N on the other hand was a fourth quartile performer in both 2016 and 2017, needless to say at the end of 2017 and in 2018 we were under severe pressure from clients to get rid of fund N, N started turning round their performance in 2018 and were first quartile in both 2019 and 2020. Those that had espoused the virtues of fund P up until the beginning of 2018 were telling us how bad the fund was in 2019 and the first part of 2020 and that fund R and fund I (which we weren’t using) were much better options and that we should swop fund P out for fund R or Fund I. Fund N had now redeemed itself and everyone was very happy with the great decision that they had made to keep the fund when it had been underperforming.
If we had changed our approach and had switched out fund P in June 2020 after 2 ½ year of underperformance we would have missed out on the spectacular bounce back that fund P has brought about, comfortably outperforming the two touted funds over three and six months.
As at date 2021/01/31
You see that despite what some people will say about great stock picking etc, in multi asset funds the majority of your return comes from the asset allocation calls made. Unfortunately due to the fact that nobody can foretell the future, asset managers will sometime get their asset allocation call wrong, resulting in underperformance. It is because of this that we firmly believe in diversifying the asset allocation call. Your portfolio can have exposure to a number of asset managers. But if one person or group is making the asset allocation call, you are not in a diversified portfolio.
Diversification is the only free lunch that we have in the investment world. Asset Managers will get their calls wrong occasionally. Unfortunately, only looking at the past performance of the asset manager is not always a good indicator of when they will be getting it wrong. We therefore need to use asset managers that blend well together, have a low correlation to one another and have sound but differing investment processes supporting their investment decisions.
And please if your advisor tells you where the rand is going or where the markets are going or which fund is going to be the best performer,…be afraid be very afraid.
CFP® CA (SA)