The Most Ignored (and Common) Term in Portfolio Analysis

If you look at just about any investment related material you’re likely see the same words written in some manner:


Yet, every day we see people judging someone’s performance, validating concepts and evaluating future potential performance by looking at past performance.  We see very active managers citing the success of their past performance.  And we even see index fund advocates citing past performance to validate their future returns.  Who is right?  Who is wrong?

Strange, isn’t it?  How the most commonly cited statistic in this industry is almost always past performance.  Yet it is also the one we are supposed to view with the most skepticism.  It all makes you wonder if there isn’t A LOT MORE to analyzing fund managers, various strategies and macro methodologies than just glancing at past returns.  I certainly think that past performance only scratches the surface on what makes a particular approach relevant.  I presume I am not the only one.  But we should be more careful about simply citing past returns to validate someone’s future potential.   There’s a lot more to the story than that….


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Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • Samuel Goti

    Quick survey: How many people in finance have read heard of David Hume?

    On that note, past performance indicates that I have never died. Therefore, I must be immortal!

  • Dave Holden

    I guess it’s pithy and easy to point to, however meaningless. Perhaps easier than making the connection between having a good understanding of POLITICS, the monetary system, transmission mechanisms and their implications for future performance.

  • Nils

    To be fair, that’s just to shield from liability. The rest of the advertising material usually heavily implies that you should judge on past performance. Unless that Performance was poor of course ;)

  • Cowpoke

    Netflix (NFLX) CEO Reed Hasting usually like to brush aside questions about his company’s sometimes-volatile stock price.

    But with shares of Netflix up 18% since Friday – and having nearly quadrupled in total this year – Hastings decided to issue a warning.

    “Every time I read a story about Netflix is the highest appreciating stock in the S&P 500 it worries me because that was the exact headline that we used to see in 2003,” Hastings said on a video chat after the company released third quarter earnings Monday.

  • http://pragcap Michael Schofield

    The fact that this has to be explained is troubling to me. Sheep among wolves.

  • Suvy

    This is a good rule for almost anything. Risk lies in the future, not in the past. Using the past to predict the future is like driving a car with the rear view mirror.

  • Anonymous

    Kant or Hume.

  • Johnny Evers

    Just to be contrary, past performance is the best way to evaluate an investment.
    Look at what happened, and why it happened, and *if* the conditions are similar, wouldn’t you expect similar results.
    If you were looking at predicting college football records, and knew nothing about college football, you would do very well just looking at past records. If you know a lot about college football, or think you do, you would probably not do so well. You’d be distracted by noise about a new coach or a recruiting class.
    If you have a 21-year-old college graduate and a 21-year-old dropout, you would probably bet on the future performance of the proven success.
    In geopolitics, if you are looking at an arms race, well then you’d look at other arms races in history. Even something like the Peloponnesian War could provide you clues to predict the outcome.

  • jaymaster

    Technical analysis is based on the assumption that past performance is a predictor of future performance.

    So there seems to be a disconnect between what a lot of analysts say and what they actually believe…

  • JanVer

    Cullen, you’ve stated in the past that you’ve never had a negative year investing and that you generated high returns. Are you saying this doesn’t actually matter?

  • Cullen Roche

    Actually, my past returns are a great example. I ran a micro event driven strategy for 5 years and it generated 130%+ returns. That strategy cannot be replicated with assets over probably $10MM. So yes, if I showed you my results and said “hey look, I can generate 100% over 5 years” I would expect you to say “is there more to the story than your past results?”

    The point is, there’s a lot more to analyzing someone’s results than simply looking at their results. I’d actually put equal emphasis on process and methodology in addition to results.

  • Billiejones

    Obviously, it’s moronic to make an investment purely based upon past returns. Does that mean past performance should be completely disregarded? …..I think to do so would be equally moronic.

    Most of us realize that there is this huge grey area in life….it’s where moderation and the happy medium reside.

    As for the phrase about “past performance and future results” ..most people recognize it as legal boilerplate.

    Should a person place much weight on a managers performance over 1 year? Of course not….. Everyone gets lucky at some point……but most in the industry adhere to the ten year time horizon. If a manager outperforms over ten year period……it’s worth taking note. Does that mean you look at average yearly performance and blindly assume you will achieve similar returns in the future?……of course not…..I’m confident most high schoolers recognize this concept as we’ll.

    If I’m a football head coach and I see a guy pass for 100 TD’s in his rookie year….. Do I automatically assume I’ve found the greatest QB of all time? Of course not….common sense. Should I just assume its a fluke and can never be repeated and thus take the QB off my watch list? You would be a moron to do so ( it costs nothing to quietly watch with an open mind). Let’s say that say QB excels every third year…..with massive SD. One year he takes you to the Super Bowl…….the next two years he’s a total flop. Do we summarily disregard him?(a QB of this caliber would surely be slated as a contender for hall of fame in ten year time frame).

    A question I would be interested in hearing an answer to would be: if we are not to place any value/weight on past performance at all….. Then what should we weight when evaluating a manager? Should we look only at his theoretical methodology….. Despite luke warm returns?People who work in the industry recognize methodologies as a dime a dozen……everyone has one. There’s nothing wrong with a methodology….you have to have one, especially if you are public and have a charter to follow. The problem is that no one methodology consistently works through different cycles and investment environments ( much like economic theories) ….In some environments a particular methodology excels, in others it significantly underperforms……..a managers long term past performance provides data on how he was able to manage the downside risk in those cycle where his methodology underperformed.

    As I’m sure everyone here knows, focusing on any ONE data point when allocating money is foolish. Past returns won’t tell the whole story, manager pedigree won’t tell the whole story and neither will methodology or back testing. If auditing/analyzing/back testing a methodology were the ONE magical formula to success…..then every jackass with a Charles Schwab account would be a billionaire.

    This is just common sense I would hope.

  • Cullen Roche

    I actually wrote this post because you were using the track record of gold buyers to try to rationalize their views. So it’s weird that you’re saying there’s so much more to the picture that matters. I mean, their actual macro thesis has been totally wrong. So if someone’s thesis has been totally wrong, yet their performance has been good, then you have to start wondering – are they lucky or good? I’d assume you say they’re lucky, but you seem to actually think these guys are good, which is bizarre to me.

  • Suvy

    That’s basically what Ben Graham says.

  • Billiejones

    I know, I’m flattered. Not sure how to rephrase this, because the message seems to continually fall on deaf ears……I’m not advocating any one paradigm….it’s actually the opposite. I think a well informed investor must always search out alternative perspectives to counter their own confirmation bias. I don’t subscribe to any one methodology, or economic theory…..they all have valid points and idiotic points. I pick and choose what i think makes sense from each and discard the rest. I don’t disregard an entire perspective simply because I dislike a particular point. What I find puzzling is that this is the way you founder MR, am I wrong?

    For example, I don’t agree with technical analysis. As another poster wisely pointed out, TA essentially relies 100% on historical data to predict future moves. I don’t condemn investors who rely 100% on TA….some have long track records of solid performance based purely on TA. I think it’s foolish to entirely disregard TA just because I don’t buy into it 100% or even 20%. While I may not use it as a large component of my personal strategy, maybe I can use it for entries and exits with the framework of solid fundamental analysis. Listening and watching with an open mind costs nothing.

  • billiejones


    I dont know if links are allowed on this blog, so sorry in advance if im breaching etiquette code here.

    Here is a video you may like….supposedly its a presentation from 2005 by Maloney. Its 16 min which may exceed your attention span (just kidding you). I have no idea how old this video ACTUALLY is, and its beside the point anyways.

    In this video, Maloney allegedly points out the potential for the crisis and the specific reasons why in ’05.

    Is it possible that these view are not the result of Maloneys work and are just parroted rhetoric from some other source?……very possible

    Is it possible that Maloney is a perma-bear and he has been calling for negative economic consequences since age 5 and in 2005 he just coincidentally was given a forum and public presence?…..very possible

    Is it possible that this is just an edited version of Maloneys presentation and the full presentation actually contained a wide ranging swath of predictions, both bullish and bearish and the video has been subsequently edited to portray the image that Maloney nailed it after the fact?…….Very Possible

    Is it possible that this presentation was staged and actual filming occurred in 2013, and Maloney grew a beard and put on an old looking suit to make it look authentic…..very possible

    All of the above is very possible and more. Frankly i’m not going to attempt to research or vet it because as I have said previously i’m not a Maloney fan boy despite being thrust into the role of defending him via what i think is just basic common sense: Listen with an open mind…..dont 100% disregard any view point because value can be gleaned from almost any source no matter how small.

    Have Maloneys predictions been 100% luck? No doubt luck has played a large role…although the same can be said for many methodologies. Not to get philosophical here but simply being born in a certain time period with a particular investment view of the world can be luck. would a methodology used by a successful investor in the early 1900’s succeed in today’s HFT and highly regulated environment? would JP Morgans strategy of holding negotiation participants hostage until they “saw his point of view” succeed in todays over regulated environment?

    Anyways, The point is, Maloney may indeed have benefited from luck, but does that mean there is ABSOLUTELY NOTHING we can glean from his point of view? Or anybody else’s?

  • Billiejones

    WOW, Cullen Im “shocked”. Why would you censor my comment? You asked for proof yesterday that Maloney bought Gold in the low triple digits……then today you claimed that his paradigm had zero value and his success was “luck”. So in logical response i researched and found a video of a Maloney presentation from 2005 calling the housing bubble and predicting the consequences……His gold call may be luck, but the Housing call surely wasn’t.

    Why would you delete that? Im sure there is a reasonable response, but i have to admit that on the surface it appears you are attempting to protect your ego at the expense of your integrity.

  • Billiejones

    Nevermind, sorry. I see the comment back now. Im just a moron.

  • Geoff

    BJ, one of the great things about this site is that it is very moderate in terms of economics and politics. On the other hand, the gold enthusiasts who call the current system a “scam” are very extreme.

  • Billiejones

    I agree that typically this site is very moderate…..its pragcap’s best attribute IMO.

    I also agree that the “maloney/gold bug type” viewpoints have some very extreme attributes and interestingly the typical “goldbug” in a comment section is even more extreme than the mascots (Maloney, Faber et al).

    Im arguing for the continued moderate approach that this blog is known for.

  • Cullen Roche

    Thanks Billie. My attention span is longer than you might think. Except with gold bugs. In that case, I try to reduce brain exposure for fear of becoming dumber, which isn’t easy to do at this point. When you’ve lost as many brain cells as I have over the years I need to be careful, you know?


    These sorts of videos from gold bugs remind me of Peter Schiff. The thing is, these guys are ALWAYS bearish about anything that’s not gold and silver. They don’t want you to buy a house. They don’t want you to buy stocks. They don’t want you to buy bonds. They just want you to buy silver and gold. So yeah, they’re bound to be right every once in a while. Does that mean their views are valid or prudent? Of course not.

    I guess my bigger problem with these views is that the fundamental understandings are just wrong. For instance, he says in that video “we will have the housing bubble pop, there will be deflation and then the dollar will collapse”. And he goes off on some rant about govt debt and how it will cause hyperinflation. He seems to have had parts of the story right, but his conclusion was totally wrong! The most important part of his entire thesis was wrong. So why should we pay heed to the small parts that were right if we can now confirm that his big picture view was wrong and based largely on a false interpretation of the way things work?

  • Cullen Roche

    You seem quick to jump on the conspiracy theory bandwagon. :-)

    You posted a youtube link that got caught up in moderation. Also, I censor the word “censor” just for fun. Because it tends to come from people being hyperbolic for no good reason. :-)

  • Cullen Roche

    Also, if I want to censor anonymous people on my website I have no problem doing so. The internet is not an open invitation for people to anonymously trash everyone else that uses it. Some people (like me) pay a lot of money to have sites hosted and it’s sad that people think it’s their first amendment right to go on someone else’s website and spew venom at them. If someone came in my house and said some of the stuff they say to me on my site they’d get put in a headlock and noogied to death (or something like that with varying degrees of violence). But for some reason every anonymous fool on the internet thinks it’s his right to act like a jerk on the internet. It’s not.

    And no, I am not saying you’ve done that, but for the sake of busting this “censorship” myth….if someone owns a website (or a house or a car or anything) and they don’t want you to come in and scream at them there then it’s their right to shut you up. I don’t tend to do that to people, but you get the point….Screaming “censorship” on the internet is silly. It’s something a gold bug will do after you ban him from trying to pump his scheme to people on your site. :-)

  • Billiejones

    “I try to reduce brain exposure for fear of becoming dumber, which isn’t easy to do at this point. When you’ve lost as many brain cells as I have over the years I need to be careful, you know?”

    – HAHAHA i dont blame you.

    “They don’t want you to buy a house. They don’t want you to buy stocks. They don’t want you to buy bonds. They just want you to buy silver and gold. So yeah, they’re bound to be right every once in a while”

    – I agree, for me this is the part i “discard”

    “I guess my bigger problem with these views is that the fundamental understandings are just wrong. For instance, he says in that video “we will have the housing bubble pop, there will be deflation and then the dollar will collapse”. And he goes off on some rant about govt debt and how it will cause hyperinflation. He seems to have had parts of the story right, but his conclusion was totally wrong!”

    -I agree here as well, although to be fair, Maloney’s strategy is a bit of a macro event play. As you know, macro event plays typically don’t pay out until the “event occurs”…its possible that looking back, Maloney will be proven completely wrong….in the meantime i just watch and listen….it costs me very little (a bit of time). For example Kyle Bass’ (Another pessimist I know, but a relatively well known macro event guy for examples sake). Kyle Bass has played several “Events”….one recent one being Greece “default”. Bass was wrong for several years until all of a sudden he was right and his CDS were paying off handsomely.

    For Maloney to be proven truly “WRONG” again, considering he is making an event play……the US economy would have to hit escape velocity so to speak…..i think that would truly prove the “event” hes banking on was unlikely to occur within any reasonable time period.

    I appreciate your willingness to post that comment… shows your character and integrity. I know you will never agree with “gold bugs”, hopefully you will continue to tolerate them though.

  • Billiejones

    You’re right. I saw the comment disappear and jumped to conclusions. I apologize.

    This is your house, you are free to invite or “kick out” anyone you like and I respect that right. From what i can tell you haven’t kicked anyone out ever. In a funny way this moderate administration is exactly what i am arguing for/ hoping you will continue. However, its worth keeping in mind that when you discount alternative views in your house simply because you disagree with particular points it doesn’t take long until you end up with an non-diverse and boring party.

    If you would prefer that i leave, I will respect your opinion and do so. I assumed that you created a public/open website because you WANTED to encourage discussion and discourse. If you want a “party” of people with homogenous viewpoints then may i humbly suggest a private message board on ning……they are far cheaper no doubt.

  • Cullen Roche

    The discourse is one of my favorite parts. I don’t have all the answers. I learn so much from you guys. It’s great. It’s just annoying when people take things personally and get nasty. That’s what I try to avoid. Gold bugs and people like them have a tendency to get very defensive about things. Anyhow, I absolutely don’t want you to leave.

    Maybe I am a bit too closed minded about the gold bug view. I just have a very strict set of principles that I stick to when advising people in this industry. Your savings is a very personal and important thing. Anyone who says to pile it all into gold and silver is being very reckless in my opinion. I know these guys aren’t advisors, but that’s why people like me exist. To make sure that gold, real estate, stock and bonds sales people don’t convince you to put all your eggs in one basket….So yes, I probably get overly defensive when I see stuff like this because it’s a very personal matter in my opinion and I think it’s sad that so many people get sucked in by what looks like pure fear mongering to me.

  • Billiejones

    Your renewed perspective is very reasonable and respectable. Thats a very rare quality among thought leaders.

  • Mark S

    Interesting observation, Cullen.

    I think performance is one of the most misunderstood concepts in investment analysis.

    Amateurs talk about the “performance” of a mutual fund, for instance, “before expenses”, as if expenses have no effect on outcomes. They do.

    They talk about average annual returns as if occasional periods of market strength and weakness are not expected. Not only are they expected; they can be beneficial.

    They tend to disregard small annual dividends, when re-invested income has a huge effect on long-term outcomes.

    Five years ago, I decided that seeking gains in the market through active management and stock picking is a fool’s errand. You have to buy the right things at the right time, know when to hold, when to add more, when to sell and what to do with the proceeds. You might get it right for a while or a long time, but the market can take away your entire gains or more at any time for any reason.

    The way to financial security for me has been to operate within my circle of influence. I avoid wasting money and invest as much as I can for reliable, growing net portfolio income. I own about thirty income-producing securities (including high, stable yields such as preferred stocks; low, growing yields such as PG, KO, MCD, etc.; and a couple of inexpensive funds for other asset types), minimize expenses by avoiding active management and other recurring expenses, and re-invest surplus income. Income is not guaranteed, but it’s much more reliable than gains, it is always realized and it is never negative. When net portfolio income significantly exceeds living expenses, I’m done.

    My investment decisions are based on things I can control or reasonably expect to occur. Too many investors – including me, for a long time – rely too heavily on hope. Good luck is not good performance.

  • Fernand

    If I had to pick a pinch hitter …. I am going to pick the guy with the highest batting average.

    It would be stupid to assume he is going to hit for me. But your odds are better.

    It’s really just a liability thing.

  • Fund manager

    As a former fund manager I would suggest that you can only analyse process and methodology through various historical periods. I don’t know any other industry where you don’t look at someone’s previous work to assess their service. I think the mistake people make in allocating to funds is not having a view on the possible market conditions. For example European equities have underperformed the S&P for 6 years. Rotation has just started so the question THEN is “who will be the best pm to perform in this environment?” …once you have your criteria then look for the fund.