With the bull market running well past five and a half years now, the standard three- and five-year performance screens for mutual funds now look really great. Once the calendar turned from February to March 2014, the major losses sustained during the global financial crisis all but dropped out of funds' trailing five-year return figures (the market hit its low in March 2009).
But those numbers forget that the average economic expansion has been roughly five years in the post-World War II era, and it's hard to tell right now how your clients' assets might fare once the bears begin to growl. True, we're in uncharted territory: The current bull market has extended well past the 4.9-year average we've seen since 1950. And with the S&P 500 headed mostly upward since it bottomed out at 676.53 on March 9, 2009, it's no wonder investors have such a tough time taking alonger-term view. That's especially true given the amount of noise in the markets and the number of behavioral biases toward shorter-term investment decisions.
Furthermore, if you look back only five years, you're judging active managers on only half their skill. It's just as important to see how they performed on the downside, through a bear market, to evaluate their ability to add long-term value. Yes, past performance is no guarantee of future results, and certainly every market disruption is different. But advisors should judge managers' performance in both the good times and bad times to better understand their investment process and see how they manage risk.
That's why, if you're using hypotheticals with your clients, make sure to emphasize the 10-year returns (if available) just as much as the three- and five-year figures. Or maybe look at how fund managers do over periods with significant intra-year volatility -- at 2011, for example, when the S&P 500 slipped 20% from late April to October but still managed to close up just over 2% for the year. You can also look at measures of risk and volatility like standard deviation, beta and downside capture. Still, those may not resonate as well with your clients. Instead, show them how the values of their accounts have changed on their monthly statements. Look back at those values over several years, perhaps using rolling 30-day periods, to help your clients see what market volatility really means to their bottom lines.
What's important is getting past complacency and unrealistic expectations of what the capital markets can actually deliver. We've seen a lot of that lately, as well as investors' misperceptions about what their funds are designed to do. In a recent MFS survey of defined contribution plan participants, 65% of those surveyed believed that index funds were safer than the overall stock market, and nearly half (49%) thought index funds delivered better returns than the stock market. And while strong stock market performance may have helped keep such misperceptions intact, these investors could be in for a rude awakening when the market eventually pulls back.
As investment professionals, it's our job to dispel myths, set the right expectations and help investors get a realistic picture of how capital markets perform over time. At times, that's a matter of questioning the answers. Are certain performance figures enough or do advisors need more context to give their clients a full picture? If active managers are to demonstrate value through full market cycles, clearly there is an upside to showing your downside.
Jim Jessee is co-head of Global Distribution for MFS Investment Management (MFS). He is also a member of the firm's management committee.