Most investors are familiar with the phrase “Past performance is no guarantee of future results”—which accompanies most all investing products and services. And for good reason! In our view, investors should heed this advice and spend more time looking forward—here’s why.
Simply put, what worked last year will not necessarily work this year, and vice versa. But more importantly, what an investment did last year doesn’t impact next year’s performance—i.e., markets are not serially correlated—which is a fancy way of saying, “Past performance is no guarantee of future results.” When examining market returns over time, you can see this is true about asset classes, countries or styles (Exhibit 1). Stocks, bonds, even commodities will all have their day in the sun eventually—but investment decisions predicated on what happened in the recent past don’t make much sense.
Exhibit 1 is a periodic table of returns. Each year shows the returns for 10 different investment categories sorted from best performer to worst. You can clearly see there’s no consistency to speak of—the various investments range from best sometimes to worst at others and everywhere in between. What did best last year often doesn’t do well the following year, and the worst performer one year can quickly rocket in performance—or not.
Exhibit 1: Periodic Table of Asset Classes and Styles (Annual Total Returns, 2001-2011)
Source: Thomson Reuters, 12/31/2000 – 12/31/2011, USD Total Return, MSCI Equity Indexes, BAC ML Bond Indexes, S&P GSCI Commodity Total Return.
Exhibit 2: Periodic Table of MSCI World Sector Returns (Annual Total Returns, 2001-2011)
Source: Thomson Reuters, 12/31/2000 – 12/31/2011, USD Total Return, MSCI World Sector Indexes.
Exhibit 2 shows the same thing with standard investing sectors—Energy, Materials, Health Care, etc. Buying last year’s winner isn’t a strategy for success. That’s not to say that the best become the worst, nor the worst become the best. No! That form of contrarian investing is no better than heat-chasing. Rather, this shows the futility of relying on recent performance to predict the future.
It’s true about individual stocks, too. Simply because it did well last year, doesn’t mean it will do well next year, and vice versa. Exhibit 3 shows what happens when you buy the previous year’s top or bottom 25 stocks in the MSCI World Index. Again, sometimes it pays to invest in last year’s winners, like in 2005 or 2007. And sometimes it pays to invest in the previous year’s losers, like 2003 and 2009. However, through this entire period, you would have been much better off simply investing in the MSCI World Index.
Exhibit 3: Equities Best/Worst and Forward Relative Total Return vs. the MSCI World Index
Source: Thomson Reuters, 12/31/2000–12/31/2011, MSCI World Index.
The next time you feel the urge to make an investment decision based on recent performance, think again. Remember: “Past performance is no guarantee of future results,” and try to think holistically. Think more forward looking, and remember to match your strategy today to what you think will happen in the future—don’t drive forward while fixated on the rear-view mirror.