Past performance is no guarantee of future performance. Investors read it all the time. Investors hear it all the time. And investors ignore it most of the time.
They do so to their peril. Not only is good past performance no guarantee of future performance, it is often a harbinger of the opposite. Simple mean reversion means high historical returns often equate to low future returns.
Fund managers and financial institutions compound the problem. They know performance sells, so they wait until past performance is good and then flood the market with new investment products when future returns are likely to be bad.
Case in point is the proliferation of international share funds in the Australian market at the moment. In the past few weeks alone I’ve noticed three new launches and a listed investment company changing its mandate so as to invest in international stocks.
The pitch is straightforward. The Aussie dollar is going to fall. International stocks have outperformed their Australian counterparts over the past few years. And Australian stocks are only 3 per cent of what is available in the world.
Just imagine all those opportunities you could be making a fortune from.
PORTFOLIOS SHOULD HAVE GLOBAL SPREAD
I do have sympathy for most of those points. You should probably have enough Australian dollar assets to fund your Australian dollar retirement. But if you have assets substantially in excess of those requirements, you should think of your portfolio as global. If you lived anywhere else in the world, would you have the majority of your assets tied up in a tiny market like Australia?
This rationale and the high Australian dollar at the time were the driving forces behind us launching the Forager International Shares Fund in February 2013. We were banging the table about the benefits of investing offshore for 12 months before and after that. Clients who acted, either investing with us or elsewhere, have done exceptionally well.
Yet that is exactly why the current wave of new products is likely to disappoint. Yes, you will get foreign currency exposure. But that is not as compelling as it was when the Aussie dollar would buy $US1.05. And if a punt on a fall in the AUD is all you are after, you can buy foreign currencies for next to nothing. There is no need to pay me or anyone else active management fees.
So then you are left with the case for foreign shares. US markets have almost tripled since the depths of 2009 and are particularly expensive. Europe is increasingly becoming so. Asia is relatively attractive, but most of the product launches I have seen give the region scant attention.
Including foreign exchange gains, the international index we measure ourselves against is up 74 per cent since the International Fund launch (the fund is up 61 per cent despite averaging more than 30 per cent in cash). That might make it easier to sell product to the average retail investor, but it makes the prospects for future outsized returns much diminished.
OPTIONS IN AUSTRALIA
All the while the Australian market has underperformed the US by a significant margin and there are attractive opportunities in our own front yard.
In late May I had lunch with a couple of small, deep-value fund managers in London. All they wanted to talk about was Australian mining services stocks. They have the whole world to work in, yet are currently adding significant exposure to Australia.
Our Australian Shares Fund already has a number of investments in common with them and we swapped a few ideas. But the whole space – mining and mining services – is pregnant with opportunity for the patient and contrarian investor.
We’re still finding attractive opportunities internationally. The flexibility to ignore a market that is expensive (like the US at the moment, for example) and focus on the most prospective markets is a huge advantage. And I still believe that, in general, most Australian investors need more international exposure. But as far as current prospects go, like those London-based fund managers, I’m most excited about the opportunities at home.
So tread carefully when considering the approaching wave of international investing options. The long-term rationale is sound but the timing is, as usual, opportunistic.
The best place to look for future performance is where past performance is horrendous.
Steve Johnson is chief investment officer of Forager Funds Management.