Study after study of the money managers who have had the best long term performance shows the same thing—-while the money managers made a lot of money over time, the average client lost money. This isn’t some sort of Ponzi scheme, it is because investors and advisers tend to buy into money managers or strategies when they are doing well and sell out when they are doing poorly.
Wall Street does a good job of hammering home the point that past performance doesn’t predict future results. Regardless of how bold that statement is on every marketing piece people still believe the most recent investment past will equal the future. Last year’s top money manager or strategy will be next year’s top performer. Last year’s bottom performer will be next year’s bottom performer. This ignores two basic facts about how markets work—-investment strategies cycle in and out of favor and everything eventually mean reverts.
It is no secret that investment styles and strategies cycle in and out of favor. In the asset allocation world there are times when value outperforms growth and times when growth outperforms value. There are times when small stocks outperform large stocks and times when large stocks outperform small stocks. In the tactical world there are times when momentum strategies do well and times when the don’t. There are markets that are perfect for counter trend strategies and markets that aren’t. The best investment strategies might crush whatever benchmark you use over time, but day to day, week to week, month to month, there will be times it underperforms. If investors are constantly getting out during the underperforming periods they usually get out of one strategy at the wrong time and into another at the wrong time.
Investments are also mean reverting. What goes up big eventually goes down to more normal levels. This happens over and over again with asset classes and strategies—Gold, Apple, Biotech, Japan, etc. Investors always like to buy into what is hot.
We see this in our investment strategies, most new client money flow goes into whatever strategy has had the best recent performance.
I get it, it is much easier for someone to reconcile buying into what is hot than it is to buy into what is not. But if you constantly rotate from what isn’t hot to what is then you are asking for mediocre investment results at best. Instead of focusing on buying past performance focus on buying into a process that should produce the best results (tolerable volatility and the best possible returns) going forward and stick with it through the inevitable ups and downs.