You may think that good past performance is evidence of future competence. You would be amazed!

The Proposition
Why not pick investment vehicles on the basis of past performance? Agreed, previous good performance may have been accidental. But surely picking a good past performer is at least more likely to be successful than picking at random?

Wrong!

The FSA's view
The FSA has put its weight behind the proposition that past performance of Trusts is no guide to the future. To quote their December 2003 report:

"Our analysis of the information available from academic and industry sources and from our own work leads us to believe that both firms and consumers place too much emphasis on past performance information. Past performance is not a useful indicator, for consumers, of future returns.

In addition, where past performance is presented selectively - with time periods selected artfully to show past performance in a good light - the information can be positively misleading."

This conclusion is strongly resisted by the industry. If true, it would undermine their claims to high management fees.

But the research is on the side of the FSA. A later study in the UK found no connection between past and future good performance, but a weak connection between past and future poor performance.

How does it work?
There are many mathematical and presentational tricks that make it possible to build an illusion of performance. Some of them are:

• Selective choice of time period (as mentioned by FSA above)
• Selective nurturing (killing bad funds and promoting good ones)
• Inappropriate comparisons (e.g. comparing the performance of a high risk fund, which needs to have high returns, with a low risk fund)
• Data mining (choosing data favourable to your case, ignoring data that isn't)
• The Law of Large Numbers (something exceptional will turn up if you pick from a large enough sample - or, enough monkeys, given enough time, will write Hamlet). Very powerful when combined with data mining.
  

The Implications
All the paraphernalia of performance records and tables are valueless unless they are processed by a specialised independent measurement agency such as Morningstar in the US. Whether even that has any value is another, and unresolved, question.