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