What does Sachin Tendulkar’s past performance tell you?

Well it tells you he is a great, talented, player with a fantastic attitude…that is all. You cannot use his past 2 years performance to predict what he will do for the next 20 years! Fairly obvious to the common man…but in mutual funds, he is willing to allow a 22 year old sales person convince him that a 29% return over 20 years will make him a millionaire..many times over!

Do not use past performance as a criteria please – whether it is cricket or mutual fund performance. Past is used to predict style, not how many runs he will score!

Past performance is not an indicator of future performance. Every mutual fund says something that in its literature. And yet, ignoring the past–in investing or in any other field–is rarely a wise move. What we should understand is that the past is only a proxy for the future. Peter Lynch says this very well when he says, “You cannot look in the rear view mirror and drive“!

The important lesson from history is that you cannot learn from history. We tend to over-emphasise the recent events of the immediate past, and worry about it. Look at the TV channels – they were all talking about the deluge on July 26,  this year too in Mumbai! Obviously July 26, 2011 could be a rainy day, a very, very, heavy rainy day – but on the other had it could be sunny!

When one looks at a fund performance, one will be guided by the past history, the true to label portfolio selection, the consistency of performance, etc. However, if you chase performance on the basis of its immediate past, you are likely to be sorry.

There is enough literature to show that equities are an excellent long term instrument and very volatile short term investment. Equities outperform other asset classes and vis-a-vis inflation. In the Indian context if you invested in the index in say 1978-79 and reshuffled it regularly (what an index fund would have done if it were available) your portfolio or Rs 100 would today be worth Rs 19,900. This is an excellent rate of return that one can hope to get.

So what exactly have stocks returned? Studies show that stocks have returned about 19.2% per year from 1980 through 2007. This number however does not include the dividends reinvested. In the US of A the dividend reinvested was TWICE the rate of appreciation. I have not come across any such study in India (would love it somebody can share it with me). Any return should be broken up into inflation, dividend and appreciation / capital gain.

Does this mean that stocks have returned 19% per year in most years? Hardly, the volatility of stocks is legendary. Markets returned a figure as high as 266% in 1992 and followed it up with a 46% fall in 1993. Thus the word average return does not make any sense for a volatile asset class like equity. Historically, we have never had a 4 year bull run! Three good years have been followed by one bad year!

But this is also an outlandish statement. Statistics is to be used very, very carefully. It is useful to use it to analyze rather than predict.

Talking about average in equities is like saying yesterday the air conditioner was not working, today it is freezing – so on an average we are comfortable!

However, what is clear is that the probability of making losses is almost (!!) nil in case a person chooses a balanced fund, managed by a good manager (fund house), does an SIP and stays invested for say 10 years at least.

This wide disparity of returns makes holding stocks for long periods of time a better idea than holding them for short periods.

If you are  interested in steadier, more predictable returns, let`s take a look at bonds, which tend to fluctuate less than stocks. As a rule, bonds cannot protect you against inflation. Let`s look at RBI bonds. It pays you 5.6% return (after tax) in a country where inflation is around 7%. When your adviser says, on an average you can expect to get 19% return over the next few years, what should you do?

Baulk! Predicting is difficult especially if it is about the future (Mark Twain). Surely this 19% return is fine, but the total return on an equity share (therefore a fund) is a function of how much dividends you get, what is the inflation rate, and the capital appreciation that you can expect. If your advisor does not know that, you need to read and equip yourself for meeting him!

What are the takeaways from this?

For long-term money, equities remain the best investment. They will not (perhaps cannot) return what they returned what they did over the past 5 years, but other asset classes cannot be compared to equities. Other asset classes like say Debt funds protect your capital and give reasonably good returns but not much inflation protection.

Manage your emotions, which may be the most important part of investing. Lynch says the amount of money you make is not a function of your IQ, but a function of the strength that your stomach muscles have! Can you take a churn?

Well diversified funds, index funds, unit linked equity funds (which by definition have a long term horizon) should all be in your wish list.

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  1. Selection committee, whether it is cricket or IIT or IIM or Infosys, goes only by past performance.

    Mr.Subra gets opportunities in training only because of his past performance.

    People read his blogs because they have enjoyed it in the past.

    All our relationships today are also reflection of past experiences.

    However limited the approach is, evaluating the past performance is essential in investing.

    Even SEBI allows listing of a company based on certain parameters of past.

    Mr.Subra may be gifted to spot performers through his special insight or some astrological capability. Lesser mortals has to depend on past.

    Today is the continuation of yesterday and tomorrow is a continuation of today.

    As Sachin’s past 20 year performance is great, in all likelihood, he would perform better for the rest of his career.

    You would go to a surgeon, who has high success rate based on past performance.

    Past performance can be safely ignored at one’s own peril. Though
    past performance does not guarantee future, it is reliable starting point.

  2. Would you prefer a HDFC Equity Fund or a some fund from Taurus. Past peformance matters, even if it does not guarantee a nickle. Despite all the volatility he is mentioning, the fact of the matter is Sensex was able to deliver 19% annualized returns, if you have stayed invested for long term.

  3. Excellent post..it is clear as to why you are an excellent trainer and a great writer. I think the difference between a Subra and a person who does not understand how to interpret past data…is clear from this post alone. Past data cannot be used for data but for style only…is my interpretation of past data correct?

  4. “Past data cannot be used for data, but for style.”- Prasad

    Mr.Subra, Prasad – I’m unable to understand what ‘style’ a past data would convey. What it means that a data should not be used as a data? Data is data!

  5. Completely and fully correct Mr. Prasad…past data is to be analysed only for style. Which means Hdfc top 200 and Bluechip are large cap fund. Templeton India Growth fund is a Value fund..so you are correct..past data is analysed just to see the style not to see the numbers…correct, fully correct

  6. People who forget the past are condemned to repeat it.- Santayana. Style is an empty non comparable useless shell unless it contains the precious numbers. Past is important. Would Mr.Subra would under go a surgery in the hands of a novice? He would definitely ask for referals and look into past success rate. What we are today is the continuation of yesterday. You cannot delink it behind clever logic.

    Past performance does not guarantee a damn thing. Agreed. But that is the starting point for one’s analysis. You cannot blissfully ignore the past totally.

  7. ‘Morgan Stanley-the listed mutual fund available at a discount-should be a good choice too.’
    i think, msgf is now delisted, and may be open mutual fund now.may be this article is a repeat one.

  8. Muthu,

    “As Sachin’s past 20 year performance is great, in all likelihood, he would perform better for the rest of his career”

    Are you saying at the age of 37 if Sachin can score a century, he can do the same (or better) 20 year later @ 57???

    :O

  9. Hi Subra,
    I agree to your point that past performance per say does not determine solely future performance .Now a days there are so many extraneous factors like exchange rate,political situation etc which can drive up or down a share price .
    For example ,in my case i had baught some stocks of infosys @3300 INR per share at 8.4 years back.When i calculated now , i found that it has given me a cool 28.5% return w/o dividend and 29.16 with dividend over these 8.4 years.But if i had bought the stock say in dec 2006 ,then the return would be much less .So i think one needs a bit of luck and patience also in stock investing .

    Regards.

  10. Hi Subra,
    I agree to your point that past performance per say does not determine solely future performance .Now a days there are so many extraneous factors like exchange rate,political situation etc which can drive up or down a share price .
    For example ,in my case i had baught some stocks of infosys @3300 INR per share at 8.4 years back.When i calculated now , i found that it has given me a cool 28.5% CAGR w/o dividend and 29.16 CAGR with dividend over these 8.4 years.But if i had bought the stock say in dec 2006 ,then the return would be much less .So i think one needs a bit of luck and patience also in stock investing .

    Regards.

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