Investment managers have a natural desire to emphasize their strengths and downplay their weaknesses. One way this can be done is by highlighting the years when the manager performed well, while not disclosing years of underperformance or a full track record. But what you don’t know can hurt you!
A recent comment about an investment manager in a TV interview allows us a look at a performance disclosure problem and the sometimes tricky evaluation of investment returns. It was stated in the lead-up to the interview that this manager had returned 150% since the stock market bottom in March 2009. At first glance, this performance sounds pretty good if you consider that the overall market had gained about 100% during the same time. But there might be something missing here. Since we follow the investment industry closely, we know that many of the managers that have done best since the stock market hit bottom were some of the worst performers on the way down. Often, the harder they fall, the higher they bounce back. So it’s possible that this manager made all the right moves at the right time to capture the big gains in the last two years, but it’s also possible that he just rode some aggressive stocks all the way down and back up again. Consider this: the S&P 500 Index lost about -55% of its value from peak to trough in the 2007-09 bear market. Some more aggressive managers were hit harder, say a -65% drop. The S&P 500 Index has since rebounded about 100%, while an aggressive manager might have gained 150%?
Which one has done better over the full period?
*Returns shown in this table are approximations and for illustrative purposes only. The S&P 500 Index is the winner! Surprised? Just looking at the numbers, the Aggressive investment manager only lost -10% more, but recovered by +50% more. If you just add those numbers together it might look like the Aggressive manager should have done better, but that’s where the tricky math comes in. Let’s look at each set of returns to see how we get these results. S&P 500 Index: For every $1 invested at the beginning, it lost $0.55 during the bear market, leaving it with $0.45. A 100% gain during the bull market equates to a $0.45 increase, adding up to $0.90 at the end. Thus, the S&P 500 Index lost $0.10 per $1 invested over the full period, or -10%. Aggressive Investment: For every $1 invested at the beginning, it lost $0.65 during the bear market, leaving it with $0.35. A 150% gain during the bull market equates to a $0.525 increase, adding up to $0.875 at the end. Thus, the Aggressive Investment lost $0.125 per $1 invested over the full period, or -12.5%. So now you can see how selected performance information can be potentially misleading to investors. In this case, disclosing the great performance over a short period of time may hide the fact that the manager’s long-term record is not particularly good. On the other hand, maybe this really is a skilled manager. Either way, we need to see the full track record to make that distinction. Please Note: The S&P 500 Index is an unmanaged index comprised of 500 stocks of large U.S. companies, representing many industries. It is a common measure of the performance of the overall U.S. stock market. Indexes are unmanaged, and it is not possible to invest directly in an index. Past performance is not a guarantee of future results.