Late last week I received an interesting email. The sender was an investor who proclaimed to be an avid reader of the Value Research publications. However, from what he had written in the email, it seemed quite apparent to me that he either didn’t read what we publish or if he did, then he didn’t digest it. The reason why I am saying this is because he has chosen to ignore one of our most hackneyed advices – that investors shouldn’t chase short-term performance.
The investor told me in his email about this seemingly great fund that he had recently purchased. The fund in question had earned a staggering amount in the last month or so. The fund’s performance was so phenomenal that it immediately impressed the investor when his agent told him about it. He didn’t think twice before leaping into it, but he should have. A poor cognisance of the arithmetic of percentages was what led him to blindly follow his agent’s advice and opt for that fund. Allow me to elaborate with a hypothetical example.
A fund, let’s call it Fund X, was one of the worst performers in the period between the markets’ January 2008 peak and March 2009 bottom. During this period, Fund X was down by 81%. Then came the market recovery in March 2009. Since then, from the low-point in March till last week’s peak, Fund X gained a highly impressive 48%. Sounds incredible, doesn’t it? Incredible, it is, but not really surprising.
The reason behind Fund X’s remarkable worst-to-best transition is that the fund is a speculative mid-cap fund. The fund’s portfolio is heavy on mid-cap stocks, which do well in rising markets, but perform even worse in bear hugs.
This is where the arithmetic of percentages comes in and should be used to decipher Fund X’s actual performance. Fund X made your Rs 100 into Rs 19 (81% down) and then increased Rs 19 to Rs 28 (48% up). Overall, it took your Rs 100 to Rs 28, which is still a 72% drop and obviously, not so impressive. To get back to Rs 100, Fund X would have to gain 360% or more, which would take some doing.
The fund that the emailing investor invested in has a similar tale to tell. In general, the funds that have done well in the recent market recovery have been the ones that were the worst hit during last year’s bear hug.
On the other hand, funds that have posted reasonable earnings of late would have invariably managed to rein in their losses through the falling markets. This brings me back to the hackneyed advice. A non-professional investor shouldn’t chase recent performance, especially during uncertain times when the markets are showing signs of recovery but haven’t really recuperated completely.
No matter how tempting the current recovery might seem, the bears cannot be ruled out of the picture completely as yet. If the market slips again, then it is funds like Fund X that will suffer the most. What investors should ideally do is ignore short-term performance. Long-term performance is what counts. And factor in the arithmetic of percentages to avoid falling into the trap that the emailing investor has fallen into. It’s easier than it looks and is more important than it seems to be.
The author is CEO, Value Research
