4 min read.Updated: 11 Apr 2021, 02:37 PM ISTJASON ZWEIG, The Wall Street Journal
A quirk in the calendar just did some heavy lifting, causing the market declines from early last year to disappear from a key fund-manager benchmark.
Fund returns have just taken some of the biggest, fastest swings in history—and could mislead investors who aren’t paying attention.
At the end of February, 40 mutual funds reported total returns of at least 100% over the prior 12 months, according to Morningstar. Among exchange-traded funds, 59 had one-year returns greater than 100% at the end of February; one month later, according to FactSet, 218 did.
What happened? Did hundreds of fund managers start popping genius pills? No, although marketing departments are probably gearing up to tout their brilliance. Instead, the ghastly losses of early 2020, when stocks fell by 34%, have just disappeared from trailing one-year returns.
As a result, websites, apps and account statements will be showing monstrous performance that’s nothing more than a happenstance of the calendar.
It’s one of the best—or worst!—examples I’ve ever seen of what finance researchers call time-period dependency. How much your investments earn always depends on when you start counting and when you stop.
Under rules set by the Securities and Exchange Commission, the 12-month return that funds report for the period ending March 31 assumes you bought before the market opened on Apr. 1, 2020 and held continuously through the end of last month, never adding or subtracting anything along the way. The same standards apply for returns over longer periods, such as five or 10 years.
In the real world, people don’t invest all their money on the first day of a month or year; they put more in whenever they can, and take money out whenever they have to. And history is always in flux: Market crashes come and go, often making managers look better by chronological accident.
“If you rely on an arbitrary and meaningless time period," says David Snowball, publisher of Mutual Fund Observer, a monthly online journal, “the results you’ll get will be somewhere between arbitrary and meaningless."
In 2010, the grinding losses of the financial crisis that ended in 2009 dropped out of trailing 12-month returns; in 2003, the 2000-02 collapse of internet stocks finally receded from the one-year record; and in October 1988, the 20% crash of Oct. 19, 1987, faded out of the 12-month history.
Such blips create what Wall Street calls “easy comps." Performance takes an automatic upward leap when crashes drop out of the record.
Consider the Direxion Daily S&P Oil & Gas Exp. & Prod. Bull 2X ETF, a leveraged fund that seeks to double the daily return of an index of energy stocks. As of the end of February, it had lost 80.6% over the prior 12 months. Just 31 days later, its one-year return had shot up to 348.5%.
“A lot of people, I think, don’t realize that returns are reported as a single path in each time period, which only a minority of investors actually experienced," says Robert Nestor, president of Direxion, which runs $25 billion, mostly in ETFs. Most users of Direxion’s leveraged funds, which are designed to enable traders to express a short-term view, hold for only a few days or weeks at a time, he says.
At Bridgeway Capital Management in Houston, six mutual funds earned returns greater than 100% over the 12 months ending March 31, according to Morningstar.
“When you have a triple-digit year this suddenly, danger signs should be flashing," says John Montgomery, Bridgeway’s founder and chief investment officer.
Even longer-term performance numbers can be skewed by short-term swings if they’re big enough. Ideally, you should look across multiple periods, including several down markets, to size up whether an investment’s gains come from a sustainable edge or just a few lucky moments.
It isn’t just the reported returns of funds and the stocks they hold that are twisted by caprices of the calendar. The Consumer Price Index fell by more than 1% from February through May 2020 as the pandemic put retail spending into a deep freeze. That will distort year-over-year comparisons in the coming months.
Even if the cost of living increases more slowly than it has recently, inflation could exceed 3% when it is reported in May for the 12 months through April 30, reckons Lyn Alden, an independent investment strategist in Atlantic City, N.J. That would be the highest year-over-year inflation recorded since 2011.
“Especially if the reported number is above 3%, that’s a good marketing pitch for gold and other inflation hedges," she says. “It’s going to be part of the narrative." Investors should be on their guard against hype about an inflation surge that may be only a statistical fluke.
Other indicators could be similarly warped, including personal-consumption expenditures, retail sales, construction spending, corporate earnings and gross domestic product itself.
The pandemic’s easy comps will linger in some year-over-year economic results until the second half of 2021. To be sure, financial markets have probably factored those distortions into stock and bond prices already.
However, an eruption of hundreds of triple-digit returns is like manna from heaven for Wall Street marketers. I’d be amazed if they didn’t flog stocks, funds and other assets on the basis of these freakish returns and the unsustainable distortions in economic data like inflation.
For the next few months, investors should be even more skeptical than usual about claims of superior performance. No one deserves credit just for a quirk in the calendar.
This story has been published from a wire agency feed without modifications to the text.
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