There has long been a debate about the use of arbitrary timeframes to judge the relative performance of funds. But this problem has become even more acute over the past decade as stockmarkets seemed to contradict claims that Britain had seen the end of “boom and bust” returns.
There is no doubt that equity investors have yielded plentiful returns over the past few decades, provided they could stomach some substantial volatility. Over the past 20 years, the FTSE 100 index of Britain’s leading shares has returned 384.87 per cent.
Of course, the index includes a degree of survivorship bias as companies are routinely brought in and kicked out. Nevertheless, investors appear broadly to have been rewarded for taking on risk in the long term.
Yet there are cautionary notes. With the third anniversary of the Bank of England’s decision to slash interest rates and begin its quantitative easing programme having passed on March 5, the majority of funds are currently boasting impressive performance figures over that period.
The FE Adviser Fund Index portfolios aptly demonstrate this with aggressive, balanced and cautious indices returning 63.29 per cent, 53.01 per cent and 44.27 per cent respectively, over three years to March 13.
Few could doubt that these figures look promising, but when the timeframe is expanded to five years the picture looks quite different. Since March 2007, the indices have returned 17.21 per cent, 13.32 per cent and 10.90 per cent, with inflation averaging 3.2 per cent a year.
What lessons can be drawn from this? The first is that any performance timeframe – whether it be three, five, 10 or even 100 years – is inherently arbitrary. They are highly unlikely to provide a comprehensive picture of short-term market movements in the future and may offer limited pointers to longer-term prospects.
But they can prove useful in identifying market trends or periods of similar market behaviour. For example, more than two-thirds of the returns from the FTSE 100 index over the past 20 years were reached between 1992-1999. In contrast, it took more than 11 years to realise the last third, with a far greater degree of volatility.
Whether this implies that we are entering a prolonged period of high volatility and low returns in equity markets is uncertain, but it helps make an argument for it. It also demonstrates the value of looking as much for consistency of returns as the overall figure.
If volatility is to be a defining characteristic, then advisers need to be all the more aware of matching the risk appetites of clients to investment products.