The past and the present

The phrase ‘Past performance is no guarantee of future results’ is probably the most widely used investment statement around, primarily because many firms are obliged to use it when marketing investment funds to the general public. Even so, we believe true investment wisdom is hidden in those eight words. Unfortunately we investors have a habit of ignoring it as we let ourselves be persuaded to invest in those funds, which boast the best recent performance, even though research shows that performance doesn’t persist. In fact the best performers of the past tend to underperform in the years ahead. This is part of the reason why the average investor in equity funds has underperformed the market by a staggering 4.75% per year over the last 20 years.

Does this mean you should ignore the past when you are building an investment portfolio? Absolutely not. For a portfolio, with broadly diversified investments within and between asset classes, the past can be a useful indicator for risk, for instance by giving an indication of the maximum possible loss you can expect to incur over a certain period of time. It can also give you an indication of what might be expected in return over the very long run. Using historical data can therefore be a useful tool to build a portfolio that fits your investment goals and willingness, ability and need to take risk.

Triple Partners’ history
Triple Partners was only established last year, so its track record is far too short to provide you with useful information on risk and return. To help paint a picture of what it could look like, we have analyzed the ‘theoretical’ historical performance of the Triple Partners Core portfolio by looking at what the underlying asset classes have returned, assuming we had used the exact same investment philosophy. In other words, we have looked at what would have happened if, for the last 17 years, we would have invested in the same asset classes, where possible with the exact same investment partners, but otherwise by investing in the relevant indices, in the same proportion and at the same total costs of investing as we have since we started in August 2010.

The graph on the next page shows the results of this exercise for the returns of the Core Portfolio since December 1993. The green dotted line since August 2007 represents our actual track record.[ref]The performance from mid 2007 until the inception of Triple Partners in July 2010 was achieved by a multi-family investment solution (“Family Office”) we established and ran with one other partner between 2007 and mid 2010.[/ref]The benchmark is built up as follows: a portfolio invested for 80% in the MSCI world index including net dividends[ref] We normally use the MSCI world all country index, which includes both developed AND developing markets. Since this index was only established in 2000 we have used only the developed markets ‘MSCI world index’ in this analysis. The difference in performance is only 0.15% annually, since it excludes both the recent outperformance of emerging markets, but also its crises’ in the 90s (Mexican Pesos in ’94, Asian crisis in ’97 and the Russian debt crisis in ’98). [/ref]and 20% in the Citigroup global world government bond index 1-5 years hedged in euro, quarterly rebalanced. However, these indices do not include investment costs and hence do not represent a real investment alternative. We have therefore subtracted investment costs of 0.6% per year to show a more realistic alternative.

Cunulative returns: Dec ’93 – May ’11

As you can see the theoretical results of the Core Portfolio, which includes emerging markets, has lagged in times when the MSCI world index was booming, but performed relatively well in times of financial turmoil. This is caused by a combination of factors.

  1. The Core Portfolio invests a higher proportion in small companies and value stocks (the MSCI index tracks mainly large and mid cap companies). The inclusion of small caps and value stocks is expected to enhance the long-term returns. The possible resulting increase in volatility is partly offset by the larger diversification.
  2. The Core Portfolio invests a small percentage (currently around 10%) in real assets, namely listed real estate companies and gold. This has a diversifying effect versus a stock-only portfolio and therefore decreases the overall risk.
  3. 50% of our equity is invested with a focus on long-term risk management. This portion basically sticks to Warren Buffet’s well-known adage: “Be fearful when others are greedy and greedy only when others are fearful.” The performance of this portion of the portfolio will therefore tend to lag in times of ‘irrational exuberance’ (see the late nineties) but recuperate when markets return to their senses.

Risk and Return
The annualized returns of the Core Portfolio would have been 6.46% with an average annual risk (or standard deviation) of 11.36%. The benchmark by comparison showed annualized returns of 4.82% with a standard deviation of 12.74%. But as illustrated by the graph, this difference in return changes depending on the time period. However, because of our wider diversification and long-term risk management, we expect the Core Portfolio’s return per unit of risk to remain better than that of the ‘simple alternative’. To further illustrate the risk of the portfolio, we have shown the best and worst 1, 3, 5 and 10-year rolling returns from the start of any month between December 1993 and June 2011 in the graph below.

Maximum gains and losses per period: Dec ’93 – May ’11


The graph illustrates the virtue of long-term investing. In the short-term, results can be erratic and sometimes heartbreaking, as exemplified by the worst 1-year period of      –26% for our Core Portfolio. In the long run, the results will generally be less variable and hopefully in line with what one can reasonably expect from investing in a diversified pool of assets. It also shows the virtues of rigorous diversification among and within asset classes and a disciplined investment approach. The volatility of the result of the Core Portfolio is significantly lower than that the MSCI stock only index, but also markedly less than the 80/20 benchmark portfolio. Not only does this allow you to lower your time horizon of investment, lower volatility also takes less of an emotional toll, which lowers the risk of untimely exits and entries. Finally, lower volatility leads to higher compounded returns (the only kind of return that counts) for portfolios that have the same average annual returns.

‘Past performance is no guarantee of future results’also applies to the future of our portfolios. Our best guess is that the returns for the next 17 years will be a little lower than the past 17 years due to the fact that we are starting with much lower interest rates and dividend yields, although at

approximately similar levels of equity valuation. What is likely is that investors in our Core Portfolio will experience declines similar (or larger) than the table above. This means that if you cannot bear a potential decline of 30% or more on your participation in the Core Portfolio in a given year, you should probably not be invested in it.

In short, nobody knows what surprises the next 17 years may hold. The analysis above illustrates the unpredictability of short-term results, and thus the importance of investing for the long run. In our opinion this is best done by focusing on the ‘3 Simple Investment Truths’ as discussed in our white paper ‘The Investment Illusion’:

  1. Control your emotions, by having the discipline to stick with your investment plan at all times.
  2. Minimize costs, by working with efficient institutional partners who share our investment philosophy.
  3. Manage risks, by broad diversification within and across asset classes.

Warm regards, and lots of investment peace of mind,

Marius and Jolmer