Much of my time is spent trying to help my clients make and keep to plans which have the best probability of meeting their needs, goals and objectives.

Once we have crafted a strategy and a plan we meet at regular intervals to measure their progress.

One of the things that we need to measure is the performance of their investments.

This is an activity which is fraught with danger as few things destroy long-term investment returns like short-term measurement.

Joe Wiggins, writing over at Behavioralinvestment.com, recently highlighted this problem in an excellent post. (Thanks Joe)

The essence of what he said was the following:

  • Our use of benchmarks – specifically for short-term* performance measurement – is a major behavioural problem and one that transforms the job of active management from difficult to close to impossible.
  • If there is any skill in active management, then it can only be identified over the long-term; short-term performance numbers are a sea of randomness searching for a narrative.
  • The challenge for active management is that short-term performance data is available, so therefore we feel compelled to measure it, analyse it and assess it.
  • To believe that short-term returns tell you anything about the skill of an active manager, is to believe that certain individuals have the ability to predict short-term market movements.  They don’t.
  • What are the consequences of professional fund investors’ use of short-term performance measurement? A great deal of entirely unnecessary activity.
  • Although I am often an advocate of doing nothing as a superior investment strategy, my criticism of the use of short-term performance measures is not about adopting a hands-off approach to active manager research, rather ensuring that the focus is on the right things.
  • It is possible to have a granular understanding of an active manager without being consistently diverted by short-term vacillations in relative performance.
  • The basic message here is this – if you are worried about short-term relative performance, avoid active managers, if not you will spend a great deal of time making consistently poor investment decisions. For those committed to active management, it is imperative to put steps in place that support and foster it.
  • If you are employing or analysing short-term performance measures, you are inevitably shaping behaviour and reducing the chances of long-term success.

As an advisor I am constantly reminding my clients to think (and act) with their best long-term interests in mind. When we start to even consider short-term data we focus on it and then start to think that we should act on it. That can have devastating long-term consequences. Looking at short-term data for long-term investors is a bit like the mythological Greek sailors listening to the Sirens. If you do that you are sure to end up shipwrecked. Just don’t listen!

* It is difficult to precisely define what is meant by long and short term and it depends on what you are talking about.  For active management I would argue anything under one year is short-term and anything over five years is long-term.  The bit in the middle we can debate.

To read the article please click here.

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