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Are you a rear-view mirror investor?
August 7, 2013

Extrapolating historical performance can sometimes be detrimental to investing. Use other parameters in conjunction with the rear-view mirror approach.

Author : Content Team

 Are you a rear-view mirror investor?

A more indepth version of this story appeared on Fundsupermart's Singapore website titled Idea of the week: Do you invest by using your rear-view mirror? This article is an extract of it.

A popular topic which arises frequently when we talk to investors is the notion of a “best fund” or “best market”. Also, upon further probing, the meaning of “best” is usually simplified to some measure of historical performance over a particular period.

Anecdotal evidence suggests a healthy correlation exists between funds which appear on the “top performing funds” list and funds which are selling well, an indication that investors tend to place a lot of emphasis on a product’s track record.

Is such an investment approach akin to driving a car by looking in the rear-view mirror?

Rule 1: Track record is important but context is everything

Admittedly, a fund’s historical track record is of preeminent importance, and even forms the core basis on which our Recommended Funds list is formulated (we maintain that a fund’s historical performance is the most objective basis on which to assess the quality of management). Nevertheless, context is everything when it comes to looking at a fund’s historical performance; it clearly makes little sense to us to compare the performance (say over the past 3 years) of an Indian equity fund with that of a Singapore bond fund, and conclude that because the Indian equity fund performed better, it is a superior product.

In addition, understanding what a fund invests in and how it achieved this “superior” historical return are also critical inputs; blindly seeking out funds with the best historical performance may not be the most prudent approach.

Rule 2: Danger of "buying high"

In addition, purely basing one’s investment decision on how well a fund or market has performed historically gives no consideration to “value”. As opposed to the logical investment mantra of “buy low sell high” (in the context of “value”), simply looking at how well an investment has performed in the past and extrapolating that return into the future can be a dangerous art, and may result in the investor “buying high” rather than “buying low”.

While it is always tempting (and popular) to pile into past winners, history is fraught with examples of how such an approach has ended in tears for the investor. For example, investors who bought Japanese stocks in December 1989 on the back of a 19.5% annualised 10-year return saw a -6.9% annualised loss on the investment over the next decade. These investors clearly failed to note some warning signs like the Japanese market’s exuberant 70.6X PE (as of end-December 1989) and 5.4X PB ratio, a hefty increase from the 23.3X PE ratio and 2.2X PB ratio observed in a decade earlier in December 1979. In more recent history, investors who ignored warnings about buying overvalued technology companies in late 1999 received a -6.1% annualised return over the subsequent decade. In this respect, we maintain that a strong focus on valuations remains a key consideration in the assessment of any investment.

Rule 3: Keep your eyes firmly on the road ahead

Ultimately, investing is about the future rather than the past; it is where asset prices move in the future which determines the success of an investment made today. As such, investors would do well to keep their eyes firmly on the road ahead, and pick investments which are expected to deliver strong returns going forward, rather than overly-focusing on their “rear-view mirrors” and sticking with those which have done well previously.

This is particularly important in the context of bond investments – superlative historical returns reflect the impact of declining yields, a situation which is mathematically-impossible to repeat (unless bond yields move into negative territory). Current yields on the various bond classes are thus more representative of their future returns.

A more indepth version of this story appeared on Fundsupermart's Singapore website titled Idea of the week: Do you invest by using your rear-view mirror? This article is an extract of it.

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Disclaimer: iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's scheme information document including statement of additional information. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer on the website.Please read our disclaimer in the website. Risk Factors: Mutual funds, like securities investments, are subject to market risks and there is no guarantee against loss in the Scheme or that the Scheme’s objectives will be achieved. As with any investment in securities, the NAV of the Units issued under the Scheme can go up or down depending on various factors and forces affecting capital markets. Past performance of the Sponsor/the AMC/the Mutual Fund does not indicate the future performance of the Scheme. The name of the Scheme does not in any manner indicate the quality of the Scheme, its future prospects or returns. Please read the Statement of Additional Information and Scheme Information Document carefully before investing.

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