Investors in mutual funds turn to one metric when they are confused about what to do? Difficult moments in investment decision making inevitably lead to that one- stop decision making tool. Every investment recommendation draws authority from this one metric that metric is past performance.
Investors draw liberally from this number from the past when drawing judgements about the future. But, history has taught us that this number is not an infallible metric to attain investment success. The most humiliating investment failures were also amply justified by past performance at the time of investing. When past performance is at its all time best, it may well be a good time to probably book profits.
But, what actually happens is often the converse. A fund scheme often draws the most money around the time its past performance looks its very best. This naturally leads to a fund manager attracting more money than he ought to or is capable of managing. The velocity of collecting money is also too kinetic for his comfort. And, opportunities to invest gainfully look the weakest just when the money flows are gushing in. This sets the fund up for long term performance failure. The very investment model which demonstrates stellar performance suddenly fails to work. Th sudden seizure in performance sets off a permanent fracture in the fund management and investors wait endlessly for the return of good times. In most cases, it probably never happens.
Investors must be Cognizant of failures. Afterall, success is knowing the DNA of failure so that one stays away from it. Or, moves away in the nick of time.
Avoiding where others go wrong is an important step in achieving investment success.- Seth Klarman
