The Future Connects To The Past

We have all seen the admonition “Past performance does not indicate future returns.” It is a little like the warning tax preparers put on your tax return. “Nothing contained herein may be true, but we are telling you so we’re covered.” It is a general catch-all liability notice to protect advisors from less than capable clients.

Does it mean anything?


Client expectations are the bane of an advisor’s existence. Most expectations are derived from a set of data that does not adequately describe the entire range of possibilities. People almost always attribute more meaning to things that have happened than to things that could have happened but did not. Thus the warning. What has happened may be a fluke, never to repeat. Other, as yet unseen things could come up.

Reality says unless something is specifically prohibited from happening, it will happen. Smart clients pay attention to things that could have happened but have not done so yet. That can lead to more reasonable assessments.

The essence of the survey is to find how likely change may be.

We know change is difficult, so assuming an investment with good performance will become terrible is unwarranted.  It is just as hard to change from smart to stupid as to go the other way. Well, maybe not quite as hard.

I happened to notice lately that Joel Greenblatt’s Gotham Asset Management earned close to 50% annually in the decade ended in 1994.  About 51 times the capital by the end. As he pointed out – before fees. Nonetheless, a stunning return.

gotham-capital-85-to-94If we were transported back to the beginning of 1995, what should we expect for the next 10 years?

Three things should spring out at you:

  1. The fund is likely much larger than it was in the beginning.  Success tends to attract capital. Enormous returns arise from special situations and these tend to be smaller. It is very easy to find $10 million special situations.  Multi-billion dollar ones do not exist. So more capital, fewer enormous gains and all small in proportion to total capital.
  2. A reasonable bet would be a change of tactics from a few highly concentrated deals to a more diverse portfolio. More singles, and fewer home runs.
  3. The manager made big money and may not want to spend the time and stress to replicate it. He might not even want to manage your money any more and give it back.

He chose 3) and returned money to the unit holders. But he did not go away, just set up new funds.

Even given those factors, I should not expect the return over the 20 years ending in 2005 to revert to the S&P 500 mean for a 20 year period. To make that real, you would have to believe Greenblatt would average -19% or so for the second decade. It is hard to picture someone who could earn 50% a year for 10 years following it up losing 19% a year for the next ten.

From the other side if a manager broke even for the first decade, would it be reasonable to believe they would make 21% annually in the second decade to reach average for the market as a whole?  I doubt it.

Take some care with expectations.  Do not allow boilerplate admonitions to form your baseline for decisions. People are reasonably predictable and the future will include things similar to what the people have demonstrated in the past.

Pay less attention to the numbers and more to what the numbers mean.

Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario.  In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.

Please be in touch if I can help you.  866-285-7772

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