Beware of 10 Year Fund Performance Data

The Global Financial Crisis of 2008-2009 was a shocking reminder of what risk looks like. Markets around the world plummeted and volatility skyrocketed. The banking system almost shut down and we came close to experiencing another Great Depression. 

Despite the unusual nature of the financial crisis, market declines of 20-50% do occur somewhat regularly. (Another market decline of a similar depth occurred only six years before the 2008 crisis started.)  Consequently, it is prudent to factor in these types of declines when examining the long term market performance track record of any mutual fund or ETF. 

When investment fund companies display returns for mutual funds and ETFs regulators force them to show 1 year, 3 year, 5 year and 10 year returns (or since inception, if the track record is shorter than 3, 5 or 10 years).

Important note: Fund companies are not obligated by the regulatory bodies to show returns beyond 10 years. This means you might not be getting the full picture – especially if the longer track record looks weak.

Until recently, funds with a 10 year track record incorporated the period that included the Global Financial Crisis. The bottom of the crisis occurred in March 2009, so until March 2019 at least some of the crisis was captured. Now that March 2019 has passed, 100% of current 10 year performance data occurred during a bull market. In other words, despite a few market jerks along the way, 10 year data no longer includes a full market cycle and no longer illustrates the full range of what an investor might experience. Current 10 year time series is effectively a case study in the ‘best case’ investing scenario.

Chart 1 illustrates the impact the financial crisis had on long term returns calculations. The bars show the worst 1 year return for the preceding decade. Until recently, the worst 1 year return occurred during the financial crisis (-43%) and was captured in 10 year time series. With the financial crisis dropping off the 10 year time series, you can see the dramatic improvement in the worst 1 year return on the right side of the chart.

Chart 2 shows how rolling the financial crisis (and the worst 1 year return from Chart 1) off the 10 year time series impacted 10 year returns. The spike on the right hand side of the chart coincides with the worst 1 year period falling off the scale. Indeed, average 10 year return has risen from the high single digits to the mid teens.

This is a deceptive representation of long term returns since it is no longer grounded by a bear market – a normal occurrence during a full market cycle.

Chart 3 illustrates how the financial crisis impacted 10 year volatility as measured by standard deviation. Again, you can see how the 10 year volatility dramatically declines once the data that includes the financial crisis rolls off. 

Losing the Global Financial Crisis off 10 year historical data means investors are no longer getting the full view of how a mutual fund or ETF performs during a market cycle. Not only is this misleading with respect to long term risk-return analysis, this potentially has an impact on how investment fund companies define the risk profiles of their products.

Regulatory documents require companies define the risk level of their products. While not perfect, standard deviation is the commonly accepted quantifiable measure of risk. The recent dramatic decline in 10 year volatility will probably mean that fund companies re-rate their funds as lower risk than before. Meanwhile, the fund itself hasn’t changed. This would be like saying a car is safer now because it hasn’t been in an accident in 10 years. Nothing about the car has changed…it is simply operating within a safer environment.

Same car. Same fund. But you can be sure as sh!t that fund companies will use this more attractive data to their advantage when marketing their products. Even fund companies that don’t purposely mislead will still inadvertently do their investors a disservice by under-reporting risk ratings for their products. After all, what company would voluntarily communicate the risk levels for their funds are actually higher than what the regulators force them to communicate?

Now – more than ever – the warning rings true: past performance is not indicative of future performance. And, if you can, try to evaluate your investments using data that captures a full market cycle.

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