Investors appear to have taken on board the perils of using past performance as their sole guide to future returns. This is not just because the FSA tells them past performance is an irrelevance but also because they have learnt the hard way one year’s top performers are seldom the next year’s winners. But is this necessarily so?
Recent research from Lipper about the persistence of performance in IMA sectors shows the picture is more complex.
It was not so long ago many investors slavishly invested in the previous year’s ‘hot’ sectors and then slavishly sold out again as returns invariably disappointed. The dislocation in markets since the credit crisis has caused investors to think twice about this ‘strategy’ and, to some extent, arrested the trend – for example, there have been few signs of money pouring into 2012’s winners, such as UK smaller companies or high-yield bonds.
“Picking the top sector over five years returned just 41.8% in the subsequent five years, whereas picking the worst sector returned a respectable 73.2%.”
However, the Lipper research has found it can prove to be better to invest in a top-performing fund – in certain circumstances. Its research showed that in picking the top sector over one year, investors received an average return of 70.7% in the subsequent five years. In picking the worst sector, they received just 41.8%.
This was only true over one year though – picking the top sector over five years returned just 41.8% in the subsequent five years, whereas picking the worst sector returned a respectable 73.2%. In the shorter term, meanwhile, it is apparently best to pick the middling sectors. The top-ranked sector averages 15th in the subsequent year, the worst-ranked sector averages 16th, but the median fund’s average for the next year is 14th.
This suggests that both momentum and cyclical factors are at work in markets. Momentum can work as a strategy in the short term but, over longer periods, it is better to try and observe the cyclicality of asset class performance.
The other interesting conclusion to be drawn from the research is that there is apparently no persistent correlation between sector rankings. IMA sectors may correlate for a couple of years but this drops away rapidly. This makes the task of carving out a truly diversified portfolio all the more challenging.
While in no way concluding investors should be basing their sector choices on past performance, the Lipper research does suggest that it is by no means an irrelevance. There are some trends that can be discerned and used to inform investment decisions – investors just need to use the information in the right way.
JANUARY 2013
Important Note: Material within this article has been complied with the help of the Marketing Hub which is part of Marketing In Practice Ltd on behalf of your professional financial adviser. The contents of this document do not constitute advice and should not be taken as a recommendation to purchase or invest in any financial product. The value of a market investment can go down as well as up and you may not get back the full amount, particularly in the short term. Before taking any decisions, we suggest you seek advice from a chartered financial planner.