12 december 2007 Advisor’s Edge Report
www.advisor.ca
Akin to Lottery Tickets
Past performance does not predict future outcome
s ta n d u p ad v i s o r
by john De goey
Maybe it’s just
me, but I can’t
help but chuckle
at the silliness of
some supposedly
serious mutual companies and the
way they promote their products.
For example, companies that
highlight their five-star funds. The
ratings may very well be true, but
are they even a little bit relevant?
Morningstar hands out star ratings based pretty much exclusively
on past performance. And past
performance, as every mutual fund
prospectus tells us, is not to be relied upon as an indicator of future
performance.
It reminds me of the cheesy
lottery kiosks that use handwritten magic marker signs that
say “$150,000 winning ticket
sold here last month.” Again,
that may very well be true, but
so what? Just because someone’s
random numbers (mostly) came
up one week and those numbers
It reminds me of the
cheesy lottery kiosks that
use hand-written magic
marker signs that say
$150,000 winning ticket
sold here last month.
were played via a ticket purchased
at a particular store has absolutely no bearing on the outcome
of future lottery numbers, tickets
or chances. If people understand
that intuitively with lottery tickets, why the ongoing disconnect
with mutual funds?
Superior mutual fund returns,
like winning lottery ticket numbers, are not predictable. No
one has devised a reliable way to
identify outperforming funds in
advance. If they did, about threequarters of all funds – those
that were identified as “about to
end up” in the second, third and
fourth quartile going forward –
would likely stop attracting assets
instantaneously.
Why would so many otherwise
rational people use something that
is an unreliable indicator of the
future to make product selections?
Can anyone point to a single peerreviewed study that suggests fund
picking is anything other than a
crapshoot? What would your clients think of you if you read tea
leaves or chicken entrails to make
your recommendations? After all,
they are every bit as reliable as star
ratings as indicators of future performance.
To make things even more
ironic, history has shown, beyond
any reasonable doubt, that cost is
a major negative indicator of performance. In other words, and as
a general rule, products that cost
more usually end up getting lower
returns – precisely because they
cost more. Furthermore, current
costs are an excellent indicator of
future costs.
A decade or so ago, there was a
mutual fund company that used
to say the manager would “win
by not losing.” The message was
that if investors simply avoided
big mistakes and did everything
else more or less the way they
always did, they’d be far better off
in the long run. Today, it seems
the most obvious element that
contributes to “losing” is “paying too much.” Yet advisors who
purport to put the interests of
their clients first seem curiously
and almost totally immune to
cost considerations.
Why would so many
otherwise rational people
use something that is
an unreliable indicator
of the future to make
product selections?
Yet the show goes on. Last
month the Canadian Investment
Awards were handed out. Talk
about awarding a crapshoot! Just
because there’s a black-tie award
ceremony doesn’t mean the award
winners were anything other than
lucky. It should insult our collective intelligence to imply causation when there is none, but that
little wrinkle hasn’t stopped the
mutual fund industry, yet. At the
very least, perhaps advisors can
all make a New Year’s resolution
to stop snowing their clients with
inferences of predictability when
there so obviously are none. AER
John J. De Goey is a Senior Financial
Advisor with Burgeonvest Securities
Limited (BSL) and author of The Professional Financial Advisor II. The views
expressed are not necessarily shared by
BSL. [email protected]