It’s no surprise that investors can’t rely on past performance when picking a manager for tomorrow, but it remains a key driver for many investment decisions, according to a new paper by Mercer.
“Despite the ever-present health warning that ‘past performance is no guide to future performance,’ there are plenty of theories in behavioural finance literature to suggest that investors allow performance to influence their decisions,” said the paper.
The paper, which looked at a number of key, long-only equity universes, found past performance is a very weak indicator of future performance over both three- and five-year time horizons. It particularly focused on the probability of future outperformance and the scale of the performance delivered.
“It is worth emphasizing that this analysis should not be interpreted as suggesting that there is no persistence in performance for equity strategies at all,” noted the paper. “The range of outcomes within each past performance group is broad, and invariably there will be some managers within each universe that do have the requisite capabilities to deliver performance that can persist over a long time frame. However, what this analysis does suggest is that, on average, allowing three- or five-year relative performance to influence manager selection is unlikely to improve outcomes for investors.”
Instead of putting such an emphasis on past performance, investors can focus on key, fundamental elements of the investment process, recommended the paper, referring to areas such as the discipline of the investment process, the degree of active risk taken, the stability of the investment team and business, the level of exposure to a proven factor premium and the size and flow of assets managed.
“While looking at past performance is certainly an important part of what a fiduciary does, it shouldn’t be the primary driver,” said Dave Makarchuk, the strategic growth leader for Mercer’s Canadian wealth business.