Buying something, whether it’s a car a carpet or a company, is a tricky process. It involves quantifying the asset being purchased, such as number of seats, size or profits, and then forming a judgement on the value of those properties. It may include a premium for branding or possibly a discount for damaged goods. In the end the buyer takes a view on the asset to be purchased and agrees a value for the transaction based on the most appropriate measure
One area though where it is hard to find a relevant measure is in collective investment vehicles. The back pages of financial magazines are full of endless tables of past performance. We all know, and the FCA takes great care to keep reminding us, that past performance is no guide to future returns.
The reason is simple.
Investment performance is a complex blend of returns of the asset class, security selection, leverage, use of financial instruments and cost. It might be interesting to know that Ocado has been the best performing share in the UK market over the last twelve months but not everyone wants to invest a significant part of their portfolio into a business that has never made any money and may never do. Funds that were lucky enough to have a holding in it did well despite its high valuation. Conversely, funds that did not want to pay too much for an unproven business suffered.
Many investors are now attracted by the apparent simplicity and low costs of exchange traded funds (ETFs) that claim to replicate the returns of a designated index. However, digging out the exact composition of their portfolios can be time consuming and surprising. Holding a futures contract on a constituent of an index is not the same as holding the security itself.
History tells us that overpaying for any asset is more likely than not to result in weaker returns in future years. While that can be relatively easy to make a judgement on value for a single stock like Ocado it is more difficult for a fund that may have over hundreds of shares in it.
Collective investments maybe like elephants. Everyone knows what they are even if they might struggle to describe them. Trying to measure them is even worse.
About the Author
Rob Davies
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