The Noise in Short-Term Performance
December 22nd, 2021
As a parent of identical twins, I’m well versed in the phenomenon of two lookalike entities exhibiting vast dispersion in behavior at any given time. So, when I encounter substantial short-term performance differences between investment strategies in the same asset class, I am disinclined to infer one is better than the other without more information.1 Indeed, even strategies with nearly identical construction rules and long-run average returns can deviate meaningfully through time. The lesson for investors is to remain cautious, as always, when interpreting past performance.
US small cap value research simulations rebalanced in different months provide perspective on the variation in outcomes arising from minute changes in methodology. Average monthly returns in Exhibit 1 reveal an 11 basis point range in long-run performance depending on the choice of rebalance month, despite identical stock selection criteria, a point we’ve used to highlight the need for caution when interpreting simulated outperformance. But even the simulations with the same long-run average returns have diverged markedly over shorter periods.
Average monthly returns for US small cap value simulations rebalanced annually in different months, January 1975–December 2020
Past performance, including simulated performance, is no guarantee of future results, and there is always the risk that a client may lose money.