Investors, including fund managers, can “overdo” their performance measurement assessments, according to a new paper by Research Affiliates. This may skew thinking and reactions towards short-term “noise”.
US-based Research Affiliates, says in “Performance Measurement – How to Do it if We Must” that technology is making performance measurement a lot easier and, because it is a worthwhile task, managers and advisors may constantly gauge whether clients are on path to meet their long-term goals.
However, doing “something” based on short-term performance measurement can degrade the long-term performance potential of a portfolio, through chasing recent winners, the paper’s author, Jonathan Treussard, says.
“If we must regularly assess performance, let’s focus on performance relative to expectation distributions, such as a strategy’s expected tracking error of returns relative to its benchmark,” he says.
Treussard likens the habit of overdoing performance measurement as being analogous with overuse of social media. He has taken the unusual step of deleting his Twitter and Facebook accounts on the past year. He does not expect many others to follow his example, though. Similarly, the notion that the investment industry will abandon short-term performance assessment is impractical, he says.
“If we must regularly assess performance, let’s focus on performance relative to expectation distributions, such as a strategy’s tracking error of returns relative to its benchmark. By doing so, we are better able to short-circuit our behavioural tendencies and recognize that near-term performance is well within the range of reasonably expected deviations the vast majority of the time.
“From this perspective, we can conclude that investors are better off doing nothing much of the time, as opposed to doing something, assuming that we have positive priors for the strategies we are evaluating.
“The choice of “doing less” rather than more also has the distinct advantage of being a trading-cost-reducing strategy. As we de-emphasize the importance of short-term performance, we also gain an appreciation for the fact that long-term performance expectations have less noise built into them.
“Therefore, we can approach the task of assessing long-term performance with more confidence, though not certainty. Over longer horizons, such as a 10-year window, excess returns fall within a smaller range of outcomes, making performance measurement and managing to these measurements…”