Performance Chasing: Looking Through The Wrong End Of The Telescope by Seth J. Masters, AllianceBernstein
Good financial advice should have a firm grounding in data, in our view—but data availability shouldn’t skew its focus.
Unfortunately, that’s often the case. The abundance of data on portfolio returns versus benchmarks and peers leads many investors and their advisors to focus far too much attention on relative returns. The result is much like looking through the wrong end of a telescope: It minimizes rather than magnifies what affects investors most—their progress toward meeting their financial goals.
To get a rough measure of this bias, we checked Google Trends, which gave the term “stock index” a score of 36, “top funds” a 14, and “financial goals” just a 3. The left side of the Display below presents these results in corresponding font sizes, from banner headline to nearly illegible fine print.
We think that these priorities are backward. In our view, the extent to which you achieve your financial goals should be the most important metric by far, as illustrated on the right side of the Display above. Defining and meeting financial goals may be no easy task, but the process of defining their goals helps investors make good decisions, and meeting their goals means getting what they really want.
Of course, outperforming benchmarks or peers is valuable, as far as it goes. As an investment-management firm, we seek to provide premium returns over time. But all too often, the search for strong relative returns prompts investors to detour far from where they want to go.
The Siren Song of Performance Chasing
Consider the left side of the next Display, which shows that over the 12 months ending August 2015, US mutual-fund asset flows have gone into funds with a five-star (top) rating from Morningstar—and out of funds with fewer stars. By definition, those ratings are backward-looking. One academic study has shown that within just four years, 86% of five-star investment managers were either given a lower rating, or they shut down completely, as shown on the right side of the Display.
This evidence strongly suggests that focusing on managers’ recent results is highly unlikely to produce superior future performance. And since asset-class winners and losers change places as well, in unpredictable patterns, trying to keep up with the “best” asset is also counterproductive.
Indeed, undue focus on recent performance can be dangerous to your wealth. As virtually every set of compliance disclosures notes, “Past performance is not necessarily indicative of future results.” Hot asset classes and investment managers tend to cool off, so focusing on and chasing the best-performing assets and managers generally yields poor investment outcomes.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.