Article on the Financial Times – “How to best avoid performance addiction” which you might have to type into Google and click through there in order to get the full article. It describes how performance is the only barometer that most (retail) investors allocate capital, so when fund managers get money, they usually are already in quite “hot” sectors due to the prior years’ outperformance. A quotation is the following:
Most asset managers exhibit “enabling behaviours” that reinforce investors’ performance addiction by selling investment products on the basis of past – particularly short-term – performance. Although we all repeat the mantra that “past performance does not guarantee future success”, we still pay too much attention to performance.
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Imagine a world in which every adviser and asset manager had to discuss three categories of investments with their clients: out-of-favour strategies worthy of consideration; high-performing strategies that continue to have legs; and “hot” performers that have had their run, from which investors should scale back their investments. It certainly would lead to rather different discussions than what typically occurs today.
Unfortunately I disagree with the conclusion. In the investment world, risk-adjusted future performance is everything. Risk-adjusted past performance is the only measurement tool. Note I mentioned the phrase “risk-adjusted” – a fund could have achieved a 1-billion-percent increase of capital by winning a $5 bet on the Lotto MAX (into $50 million) which would be very good fund performance, but the risk taken to get that performance was ridiculously stupid.
Most retail investors know nothing about performing this risk calculation when glossing through various promotional literature of mutual funds.
From an individual perspective, you should absolutely crave inefficient capital allocation (e.g. what we are likely seeing in the Vancouver Real Estate market). It causes less capital to chase other assets (which presumably will exhibit relative undervaluation) which you can snap up for cheaper prices. From a macroeconomic perspective, however, it is very unhealthy for economies to have significant inefficiencies, so when the focus of the speculative boom busts, you usually have to content with economic fallout (e.g. late 19th century/early 20th century railroad companies, mid 20th century automakers, the internet stock bubble, 2008 US real estate market etc.).