Performance Persistence

January 27, 2010

Using a survivor bias free mutual fund database, S&P Global Research reports that using the past five years’ annual returns as well as cumulative five-year historical returns to find future winners is roughly equivalent to rolling the dice.

Over the five years ending September 2009, only 15 (4.27%) large-cap funds, 7 (3.98%) mid-cap funds, and 21 (9.13%) small-cap funds maintained a top-half ranking over 5 consecutive 12-month periods. No large- or mid-cap funds, and only one small-cap fund, maintained a top-quartile ranking over the same period.

So, if selecting funds based on short-term performance, even 5-year performance, isn’t the key to finding future winners, what is? When seeking to select winning strategies, there is no substitute for looking at much longer-term performance histories and doing the necessary due diligence to understand why a given active investment approach is likely to persist in generating excess returns in the future. Then, once an active strategy is selected, expect periodic periods of short-term underperformance.

Leave a Comment » | Investor Behavior, Markets | Permalink
Posted by Andy Hyer

Running Through the Dynamite Factory

January 27, 2010

I had to read this article twice—and I still couldn’t believe what I was reading. According to the Wall Street Journal, the State of Wisconsin Investment Board has approved a plan to leverage their bond portfolio to boost their state pension performance.

The strategy calls for leveraging pension funds’ safest asset—government or other high-grade bonds—while reducing exposure to stocks.

Wow. That sounds like a great idea. And I was concerned about retail investors piling into bonds at the possible bottom of the interest rate cycle.

Wilshire Consulting, which advises pension funds on investments, says leverage helps the funds meet their long-term return targets without relying too heavily on volatile stocks, or tying up their money for long stretches in private investments.

Of course no one wants to rely on volatile stock returns—so just leverage your bonds to make them more volatile! I’m pretty sure this will work out well. As the old saying goes, “If you run through the dynamite factory with a match, you might live, but you’re still an idiot.”

Leave a Comment » | Just for Fun, Markets | Permalink
Posted by Mike Moody

Bill Gross and the Ring of Fire

January 27, 2010

With a nod to Carmen Reinhart and Ken Rogoff’s book This Time is Different, Bill Gross of PIMCO, in his most recent commentary, concludes that the new normal looks a lot like the old normal. In other words, economies now are behaving pretty much like they always have when there is a financial crisis and a large buildup of public debt. (See also this excellent commentary on Mr. Gross’s letter from FT Alphaville.) Mr. Gross draws out some investment implications from the following nice graphic:

(click to expand chart)

Essentially, the new normal could consist of the emerging market economies being much more healthy—and more investable—than many overindebted developed economies. Obviously there will be plenty of profitable and outstanding companies within countries in the ring of fire, but Mr. Gross thinks it will also pay to have a more global approach. The world order is changing and your investment strategy will need to be flexible and adaptive (can you spell “tactical asset allocation?”) to keep up.

Leave a Comment » | Markets, Tactical Asset Alloc, Thought Process | Permalink
Posted by Mike Moody

High RS Diffusion Index

January 27, 2010

The chart below measures the percentage of high relative strength stocks that are trading above their 50-day moving average (universe of mid and large cap stocks.) As of 1/26/10.

The 10-day moving average of this indicator is 69% and the one-day reading is 44%. This oscillator has shown the tendency to remain overbought for extended periods of time, while oversold measures tend to be much more abrupt.

Leave a Comment » | Markets | Permalink
Posted by Andy Hyer