Arbitrary data offers blurred picture

Neither short nor long timeframes offer certainty for the analyst, but despite market vagaries, data can offer useful insights, which helps advisers match products to investors’ risk appetite.

There has long been a debate about the use of arbitrary timeframes to judge the relative performance of funds. This problem, however, has become even more acute over the past decade as stockmarkets seemed to contradict claims that Britain had seen the end of “boom and bust” returns.

There is no doubt that the past few decades have yielded plentiful returns for equity investors, providing they could stomach substantial volatility. Over the past 20 years the FTSE 100 index of Britain’s leading shares has returned 384.87%.

Of course, the index includes a degree of survivorship bias as companies are routinely brought in and kicked out. Nevertheless, investors appear broadly to have been rewarded for taking on risk in the long term. (AFI continues below)

Yet within such an analysis there are cautionary notes. With the three-year anniversary of the Bank of England’s decision to slash interest rates and begin its quantitative easing programme having passed on March 5, the majority of funds boast impressive performance figures over that period. Indeed, the FE Adviser Fund Index (AFI) portfolios demonstrate this with the Aggressive, Balanced and Cautious indices returning 63.29%, 53.01% and 44.27% respectively, over three years to March 13.

Few could doubt that these figures look promising, but when the timeframe is expanded to five years the picture looks different. Since March 2007 the indices have returned 17.21%, 13.32% and 10.90%, while inflation averaged 3.2% a year.

So what lessons can be drawn from this? The first is that any performance timeframe, whether three, five, 10 or even 100 years, is inherently arbitrary. They are highly unlikely to provide a comprehensive picture of short-term movements of markets and may offer only limited pointers to longer-term prospects.

Where they can prove useful is in identifying market trends or periods of similar behaviour. One such might be to look at the fact that more than two-thirds of the return from the FTSE 100 index over the past 20 years were reached between 1992-1999. In contrast it took more than 11 years to realise the last third, with a far greater degree of volatility.

Whether this implies that we are entering a prolonged period of high volatility and low returns in equity markets is uncertain, but it helps make one argument for it. More importantly, it demonstrates the value of looking as much for consistency of returns as the overall figure.

If volatility is set to be a defining characteristic then advisers need to be all the more aware of matching the risk appetites of clients to investment products.