Slow and steady moral of the story

The results of the Hare and Tortoise report highlight the “dangers” of the industry using simple compound or point to point returns as a performance measurement tool, according to Brillient! analyst Deirdre Keown.

Keown says fund managers and research houses continue to issue simple compound data despite them “knowing full well” that it can be misleading if interpreted incorrectly.

“A naive adviser looking only at our simple compound returns would consider the Hare a winner over the Tortoise, and by extension that timing the market was a good investment strategy,” she says.

“In fact, the key finding is that for all the time and effort investors and advisers take in trying to time the market, the returns achieved as a group are very little different to those that would be achieved by a disciplined buy and hold strategy. And of course, the cost of a Hare strategy is considerably higher.”

Brillient! director Graham Rich believes simple compound measurements are a “complete nonsense”, because they represent a “simple chance that some individual somewhere may have got that return”.

“In practice the chances of an individual getting that return are very slim, as very few investors invest precisely at the beginning of a measured investment period and withdraw precisely at the end of it.

“There’s a very high chance that returns for one investment period and therefore its simple compound return could look substantially different one month, or one week, or potentially even one day later.”

By contrast, Rich says, rolling average returns represent an average of all one-year returns achieved over an investment period, and are therefore a “useful foil” to simple compound returns.

“They give a much better indication of typical historical returns achieved over an investment period, and therefore give a better idea of how all sorts of different investors would have done over a period.”

The results also display the folly in attempting tactical asset allocation, with Keown commenting the Hare’s performance is “mixed at best” over the survey’s asset categories and investment periods.

“The Tortoise has achieved very similar results with a strategic buy-and-hold approach on the basis of one-year rolling average returns, and probably better results on an after-fees basis,” Keown says.

She acknowledges, however, that the survey Hare was making industry average investment and divestment decisions, and that some planners would therefore make better decisions than others.

“Nonetheless, the survey shows the average tactical asset allocation (TAA) decisions of platform and wholesale investors aren’t adding all that much value (before or after associated fees),” Keown says.

Farrelly Consulting principal Tim Farrelly says the survey indicates there “isn’t enough real hard analysis by industry on the outlook for particular investment sectors, nor enough discipline in short term investing”.

Farrelly says some results were surprising and others were totally within expectations, with the international equities asset class being a “classic example of where the industry got it horribly wrong”.

Very few financial planners have tried TAA in client portfolios over the years, he says, and “most of these have given up”.

He says most planners’ understanding of TAA is to invest more money in markets they think are going to perform well over an investment period, and divest similarly out of markets that don’t appear as attractive.

“The problem with this approach is that quite often they manage to get into the market at the right time, but then find they have to devise a strategy for getting out,” Farrelly says.

“The key to successful TAA requires getting two investment decisions correct — and that’s no easy task.”

Planners also find it difficult to implement TAA because of the time and administration involved in getting clients to sign off on an investment decision.

Given that very few planners have the ability to make decisions on behalf of clients without authorisation, he says, it could take three or four months to push the TAA decision through.

“If a planner’s got a hundred clients, he or she’s pretty much got to make a hundred phone calls and get sign-off from a hundred clients.”

Farrelly added that a tendency by industry to get caught up in fads, results in planners often investing in a strong performing market late in the cycle, “as often as not just in time to see the market crumble away”.

“When any broad asset class, such as international or Australian equities, has run long and hard for a while, most often that’s a good indication returns are going to be poor for three, five or even 10 years afterwards,” Farrelly says.

Another classic trap that he says planners and clients fall into is to focus on returns and not underlying valuation, “assuming that when something looks good it will continue to be good when fact they are chasing past returns”.