The Untold Story of Trailing Returns

• By: admin
• On: 01/02/2024 13:06:45
• In: News
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This is an excerpt from NCPERS Fall 2023 issue of PERSist, originally published October 24, 2023.
 
Regardless of your level of sophistication as an investor, when reviewing public investment strategies, the start of your evaluation process is likely often the same: “What do the trailing returns look like?” In other words, are the 1, 3, 5, and 10-year trailing performance numbers better, worse, or largely similar relative to other active or passive options being considered? This tendency to rely on trailing performance does not apply exclusively to comparisons between competing investment options, we also commonly use trailing performance to evaluate if a portfolio's objectives are being met over time and/or if an asset class (represented by an index) is worthy of new or ongoing inclusion in a portfolio. Unfortunately, trailing performance simply doesn't tell the whole story.

Every trailing return reviewed for an investment strategy, portfolio or index has an “untold story” each time its performance is updated for a new time period (e.g., September 30^th vs. December 31^st trailing performance). This is because there is a largely unsung “rolling-return” factor associated with updating trailing performance for each period, and while we all know the factor exists, it rarely gets a second thought when evaluating trailing returns. This “out with old, in with the new” methodology is commonly referred to as “endpoint sensitivity.” In simpler terms, when you choose to start the evaluation period and when it ends can have a dramatic impact on the presentation of the results.

To further illustrate this point, consider that most client portfolios were recently faced with an example of the extreme impact that end point sensitivity can have on the presentation of trailing results. The table below contains the trailing benchmark performance of a traditional balanced investment portfolio (50% Russell 3000 / 10% MSCI EAFE / 40% Bloomberg US Aggregate) using two different endpoints one year apart. As you can see, adding 2022's negative performance to the trailing period calculations has a significant impact on the presentation of long-term performance results. To further visualize how a cursory review of these results could potentially lead to inaccurate snap judgements of portfolio success or failure, we also highlighted returns above 7.5% as a reference point for a hypothetical pension plan's assumed rate of return.

The simple addition of 2022's performance to the trailing return calculation shifts the hypothetical pension portfolio from achieving its return target for each trailing period, to requiring 30 years of trailing results to exceed the static hurdle.
What's the primary takeaway? First, it is a fascinating piece of mathematical market trivia.  Second, we believe it is important for clients to understand the significant impact that 2022 had on investment results and notably trailing performance results. Third, extreme swings in short-term market performance can create the perception and/or urgency among stakeholders that long-term, successful strategies may need to be changed. Finally, and most importantly, we would like to emphasize patience, and to the extent possible, removal of emotion when evaluating trailing performance results, especially after periods of market distress.

Important Disclosure Information
 
For educational purposes only and should not be regarded as investment advice. The views and opinions expressed are those of AndCo Consulting. Statements are not guarantees, predictions or projections of future performance or of any outcome. This contains forward-looking statements, estimates and projections which are inherently speculative and subject to various uncertainties whereby the actual outcomes or results could differ materially from those indicated. All data and figures for the market indices are sourced from Morningstar Direct. AndCo cannot guarantee the accuracy, adequacy or completeness of certain information.
 
AndCo Consulting is an investment adviser registered with the U.S. Securities and Exchange Commission (“SEC”). Registration as an investment adviser does not constitute an endorsement of the firm by securities regulators nor does it indicate that the adviser has attained a particular level of skill or ability. AndCo Consulting and NCPERS are not affiliated.