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Thomas J. Feeney
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Tom Feeney began his work in the investment industry in 1969. Clients have included cities, states and major corporations, as well as numerous religious, charitable and other not-for-profit organizations. In his early career Tom served as Executive Director of Stewardship Services, Inc.,... More
My company:
Mission Management & Trust Co.
My blog:
Measure of Value
  • Past Performance May Be Misleading 0 comments
    Apr 18, 2011 11:29 AM

    The vast majority of investors view past performance as the quality measure of investment managers.  Of course, they’ve read the caveat on all performance reports: “Past performance is not necessarily indicative of future results.”  Most ignore that completely, especially if a strong track record extends to a decade or more.

    Implicit in the confidence born from observing an extended strong track record is the assumption that the manager understood market prospects better than did his/her peers.  That manager foresaw what was coming with greater clarity than did other managers.  Of course, that assumption could be true in any single instance, but I would argue that it is highly flawed. 

    Every investment management decision plays itself out over a particular set of future circumstances, a great many of which are unforeseeable in advance.  If we had the luxury of viewing a given decision’s result 100 times instead of just one, we would have a far clearer understanding of that manager’s actual foresight.  Would that decision prove right 70% of the time or, perhaps, just 30%?  Did the manager get lucky this time, despite the probability that the same decision would prove wrong more often than not?

    It is critically important for investors to fully understand this as a probability business, not a certainty business.  Managers make decisions based on a long list of assumptions.  Some will prove correct, some incorrect, largely derived from the psychological reactions of households, businesses and governments.  Under either similar or dissimilar circumstances, those entities may react differently leading to a different conclusion.

    Investment decisions made in the last dozen or so years have taken place during a unique era in U.S. history.  Leverage amounts and equity valuation levels have reached unprecedented heights.  These conditions may prove to be long-term precedent or they may provoke “What were we thinking?” reactions in future years.  We can’t know, but probabilities would suggest that what appears unsustainable today will not be sustained.  In all likelihood, excessive leverage will continue to be unwound, and levels of equity valuation common before the debt bubble era will again prevail.

    Investors should evaluate carefully whether investment manager performance earned through the era of runaway debt is likely to be predictive or whether it is the fortuitous result of a phenomenon unlikely to be repeated.
    Selecting tomorrow’s best managers is problematic at best.  You will strongly elevate your potential for success if the managers you examine explore the full spectrum of possible investment outcomes and structure portfolios fully conscious, not just of the rewards for being right, but of the penalties should the market prove them wrong.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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