Why You Should Beware of First Dates

Imagine that you’re the marketing director for MegaAlpha Investments and you want to advertise two of your mutual funds. In the September 2011 issue of Performance Chaser magazine, you place the following ad:

Are stocks still worth the risk? Not anymore. Over the last three years, the S&P/TSX Composite Index delivered annualized returns of just 0.2%. Meanwhile, the MegaAlpha Awesome Income Fund earned 6.4% a year. Rather than relying on a disappearing equity premium, our managers delivered reliable yield and significant growth with a portfolio of the highest quality government and corporate bonds.

Three months later, in the December issue, you run a different ad:

Are stocks still worth the risk? You bet. Over the last three years, the MegaAlpha Awesome Equity Fund  delivered annualized returns of 12.5%, dramatically outperforming the DEX Universe Bond Index, which returned just 7.7%. Rather than relying on the perceived safety of bonds, our managers took advantage of generous dividends and capital growth in a portfolio of leading Canadian companies.

Do you think I made those numbers up? Nope. Both the index returns and the funds’ performance are real—except the “MegaAlpha Awesome Income Fund” is actually the iShares DEX Universe Bond Index Fund (XBB), while my bogus equity fund is the iShares S&P/TSX Capped Composite Index Fund (XIC).

All I did here was change the start and end dates for the three-year performance data. The first ad uses numbers as of August 31, while the second example ends on November 30. By shifting these dates just 91 days, the entire argument gets flipped on its head. One ad makes stocks look pathetic, while the other makes the last three years look like a screaming bull market. And yet the two sample periods have 33 of their 36 months in common.

How can this be? The first sample begins just before the Lehman Brothers collapse in September 2008, while the second one starts after the market had already dropped about 30%. The two ads demonstrate how easily dates can be selected to make virtually any investing strategy look either magic or tragic, depending on your motives.

2001: A Spud’s Odyssey

How many times have you heard that the last decade “proves” that a simple buy-hold-rebalance strategy no longer works? That claim is a prime example of how you can use start dates to manipulate performance data to either celebrate or condemn the same investment approach.

To show you what I mean, I compiled some historical performance data for the Global Couch Potato, a portfolio of 40% bonds and 60% equities (divided equally among Canadian, US and international). These are index returns only, without accounting for fees, but it’s the relative figures that are important here. How would the Couch Potato strategy have served an investor who cashed out at the end of 2010? It depends entirely on your start date:

• Since 1996, the Global Couch Potato delivered an annualized return of 6.65%. Index investing rewarded investors with excellent returns during a 15-year period that saw both strong bull markets and two of the worst market meltdowns in history.

• Since 2001, the Global Couch Potato delivered an annualized return of 3.74%. An active money manager could argue that the strategy doesn’t work, because it delivered a decade of dismal returns that barely outperformed T-bills. Time for a phone call to MegaAlpha Investments.

• Since 2003, the Global Couch Potato delivered an annualized return of 6.15%. Index investing rewarded investors with excellent returns during an eight-year period that included both a strong bull market and one of the worst market meltdowns in history.

So take your pick. If you want to sing the praises of the Couch Potato strategy, look back 15 years or only eight. Or you can start your assessment just before the dot-com bust and use this one 10-year period to “prove” that passive investing doesn’t work. However, if you decide to take that approach, act now because you have only 13 months left. Once 2012 is in the books, all 10-year fund performance data will start with 2003 and the report card may look quite different.