|
The Street view-April 16, 2010 |
|
Comments(0) |
Posted by
Quantum on
Friday, April 16, 2010
You see a very appealing advertisement…
You see a seductive photograph of a product…
You may find an attractive women vouching for a brand…
Subtle yet suggestive communication, that provides you with a lot of “noise” but not necessarily “useful” information can distract you in taking decisions that may not be in your best interest.
Well, interestingly, a similar kind of seduction can be found in financial product advertisements. For example, the spate of mutual fund advertisements showcasing great performance numbers is a case in point.
Nothing wrong in presenting performance numbers, but you need to delve deeper to distinguish “noise” from “information”.
You would normally find articles focusing on brand wars authored by various marketing gurus. Brand wars happen in any industry where a high decibel ad campaign is going on to increase market share. In contrast there seem to be fewer articles written about what performance numbers reveal or what they do not reveal.
However the more I watch these advertisements, the more convinced I am that they do not tell the complete picture. Most advertisements show ‘1-year’, ‘3 or 5-years’ and ‘since inception’ return numbers. By highlighting the CAGR returns, the funds sometimes do not give out the complete picture.
Look at the performance numbers given in the table below. You may be neutral to all of them if your investment decision was simply focused on the “since inception” numbers.
| | Fund A | Fund B | Fund C |
| 1 Yr Return | 90% | 20% | 90% |
| 3 Yr Return | 80% | 8% | 20% |
| Since inception | 10% | 10% | 10% |
However if you were to see the table below and could see the returns for each year of the past 5 years then your investment decision might not remain neutral. Each of them gives you a different picture on how they achieved a “since inception” return of 10%.
| Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 |
| FUND A | -20% | 50% | -50% | 70% | 70% | -40% | 90% |
| | | | | | | | |
| 1 Yr Return | 90% | | | | | | |
| 3 Yr Return | 25% | | | | | | |
| Since inception | 10% | | | | | | |
| | | | | | | | |
| Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 |
| FUND B | -15% | 50% | -20% | 50% | 30% | -20% | 20% |
| | | | | | | | |
| 1 Yr Return | 20% | | | | | | |
| 3 Yr Return | 8% | | | | | | |
| Since inception | 10% | | | | | | |
| | | | | | | | |
| Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 |
| FUND C | 70% | -20% | 70% | 50% | -40% | -50% | 90% |
| | | | | | | | |
| 1 Yr Return | 90% | | | | | | |
| 3 Yr Return | -17% | | | | | | |
| Since inception | 10% | | | | | | |
Each one tells a different story.
Purely based on these numbers it appears that Fund A may have a concentrated portfolio. My assumption is because the declines or advances are high. Declines are as high as -50% while advances are again as high as 90%
Fund B appears more stable with lower swings.
Fund C on the other hand exhibits high volatility. It indicates either counter cyclicality bets or use of derivatives. For example: In some years while Fund A and B are showing negative returns, Fund C exhibits positive returns. Similarly in some years where Fund A and B is exhibiting positive returns Fund C exhibits negative returns.
If you are risk adverse investor, you would avoid funds with wild swings or you will avoid funds with counter cyclic returns, as you may not be sure of the strategy that the fund manager is following.
The conclusion is to ask and look into the details before you come to conclusions on the performance of the fund.
Disclaimer:
The responses expressed here are strictly for information and explanation purpose only. The responses are meant for general reading purpose and not to be considered as an investment advice / recommendation. This information is not intended to be an offer or solicitation for the purchase or sale of any financial product or instrument. Readers are advised to seek independent professional advice and arrive at an informed investment decision before making any investments. The Sponsor, The Investment Manager, The Trustee, their respective directors, employees, affiliates or representatives shall not be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way from the information contained in the responses.