Past Performance is No Guarantee

May 10, 2018


The desire to chase a hot manager is so hard to resist—even for professionals. The news media loves to tout a manager after a huge home-run performance. They discuss their success as if they are clairvoyant savants with supernatural abilities.

Consider three examples:

  • Between 2004 and 2016, Bill Ackman’s Pershing Square Fund increased by 500%. As a result, Ackman received tremendous recognition and was a regular on CNBC.
  • John Paulson, a hedge fund heavyweight, successfully bet on the collapse of the housing market, netting him nearly $15 billion.
  • During the “lost decade” of 2000 to 2009, Bruce Berkowitz led the Fairholme Fund to total gains of 245%, or 18% per year. Over the same time, the S&P 500 went nowhere. This earned Berkowitz “fund manager of the decade” honors.
It is hard not to want a piece of the action. It ranks right up there with trying to hit the winning lottery ticket. The allure of quick money releases all sorts of endorphins, causing a variety of emotional decisions.

If you are apt to chase past performance, do so very carefully.  

Even if you find a solid manager with a great record, it is not a smooth ride. It’s important to have the right time frame and the grit to stick it out.

Analyzing the average investor in the Fairholme Fund is instructive. Although the fund delivered solid performance during the lost decade, it was volatile, and most investors did not understand what was necessary to experience success.

The average investor in Fairholme jumped in and out at all the wrong times. This turned average annual performance of 18% per year into dollar-weighted losses of 11% per year.

Emotional and irrational behavior was not unique to Fairholme investors. According to JP Morgan, between 1998 and 2017, the S&P 500 averaged 7.2% per year. The average investor earned a meager 2.6% per year during that time.

Meanwhile, according to famed investor Joel Greenblatt, the statistics for top-quartile managers for the lost decade were stunning:

  • 97% spent at least 3 of 10 years in the bottom half of performance
  • 79% spent at least 3 years in the bottom quartile
  • 47% spent at least 3 years in the bottom decile.

Even great managers lag the market for considerable periods of time. Ackman, Paulson and Berkowitz have all struggled to duplicate their previous success.  

There are several valuable lessons from these examples.

First, understand the people and the process. If the key manager leaves a fund, this should be a legitimate reason to revisit the strategy.

Similarly, understand the investing process. Is the goal to find “one-off” events that might only happen once every 25 years or is it something understandable and repeatable?

If the goal is to root out one-off events like John Paulson, then good luck. There will be lots of excitement for the home-run they hit, but they don’t mention the 10 times they struck out. A strategy that is understandable and predictable gives a much better opportunity to measure the manager and strategic performance.

What is the need for liquidity? Many top performing funds will plow money into very illiquid or privately held assets. That sounds great, until you need money. Most hedge funds and private equity funds have “lock-ups” in which you cannot access your money for a considerable period. If you have a liquidity need, or get panicky, you will most likely not get the performance that comes from being a long-term, patient investor.

Unless you are a billionaire, don’t compare your investment strategies to the mega-wealthy. Although it is interesting to study people with massive wealth, it is potentially dangerous to follow their investment strategies. Consider a billionaire who spends $1 million per year on their lifestyle. That means their spending relative to their net worth is 0.1% per year—virtually nothing.

The mega-wealthy can leave money invested far longer in complicated or illiquid strategies. Many strategies can take 10 (if not 20) years to fully appreciate. The mega-wealthy can also be far more tolerant of volatility.

There is nothing wrong with learning from highly successful investors. However, recognize that above all, your investing strategy has to work for you. You have a unique set of liquidity and cash flow needs. You have time frames unique to your personal goals. You have a unique tolerance for volatility. Thoughtfully assessing these issues first will increase your opportunities for determining if a manager or strategy is right for you.

Dave Sather

Sather Financial Group

Dave Sather is a CERTIFIED FINANCIAL PLANNER and President of the Sather Financial Group, Inc. Sather Financial Group is a $400 million “fee-only” wealth management firm based in Victoria. Sather Financial is ranked as one of the top independent wealth management firms in the country according to Financial Advisor Magazine. Dave was raised in El Paso, received his B.A. in Business Management from Texas Lutheran University and received his M.B.A. from Texas A&M University. He has spent the past twenty years in the financial analysis, investment and banking industries. Dave is an adjunct professor in the business program at Texas Lutheran University. Additionally, Dave is a director of Business Bank of Texas as well as the Chairman of the Finance and Investments Committee for the Brownson Children’s Home and is a member of the Executive Advisory Council at Texas Lutheran University. He resides in Victoria, Texas.
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