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Be a Tortoise, not a Hare

19 January 2023

 

Past performance is not a reliable indicator of future performance. We write this phrase in small print below every ETF performance chart. And rightly so. Yet, like many asset managers, we find that investors still buy our ETFs more after periods of strong market performance, choosing to sell when markets fall.

Managing human psychology

Despite our disclaimers, some investors seem to think that past performance is a reliable indicator for the future. Why so? Because humans rely too much on emotion and instincts when investing. Too many people start investing after a few years of rising stock prices, only to sell in a panic after a market fall.

This is the opposite of what one should do. Instead, many of the most celebrated investors believe that it pays to go against the herd – buy when others are selling and sell when they’re buying.

Academics have researched the tendency of investors to be swayed too much by past performance, leading to the field of “behavioral finance”, which identifies the following behavioral biases:

  1. Recency bias: People tend to think that a recent trend will extend into the future. For instance, if an ETF has risen for three months in a row, investors might think it would continue to go up in value.
  2. Herding bias: Perhaps because they fear missing out, people often decide to do something mainly because many others are doing it. This bias caused the great investing bubbles of history, such as the Dutch tulip mania of the 1630s when the price of tulip bulbs reached extraordinarily high levels.

The trend is not always your friend

In the past two volatile years, we have seen these biases affectation flows in our ETFs. In 2021, a year of buoyant markets, VanEck Europe gathered more than EUR 2 billion in net ETF inflows. In 2022, though, markets corrected, and our net ETF inflows moderated to about EUR 0.5 billion. Then, following early 2023’s market uptick, our ETFs attracted EUR 0.15 billion in the first two and a half weeks of January (data as of 18 January).

Ironically, investors’ timing may not have been perfect. The many who invested in 2021 are likely to have made losses in 2022, whereas only a few brave investors who bought in 2022 would have gained from the recent equity and bond market rally. Of course, anything could have happened, and I am definitely not saying that investors should always step into the market during a down year and step out in a good year. But I do say that people are probably better off when they stick to their long term plan, keep adding investments periodically, even in (or better, especially in) periods were the markets go down. Our fund flows illustrate that extrapolating past performance can be a fools’ game.

Be a Tortoise, not a Hare

Beware survivorship bias

Another type of bias for investors to beware is “survivorship bias”. Rather than being a characteristic of investor psychology, this refers to the fact that asset managers tend to close funds that perform badly. Why do they do so? Not because of the bad performance per se, but because of the fact that underperforming funds typically attract few assets which negatively impacts their profitability. The end result, however, is that only the best performing funds tend to survive. Cynically, some asset managers routinely launch large numbers of funds expecting only a few to perform well and remain open.

Unfortunately, the funds industry is not mindful enough of survivorship bias. Often investment advisors will recommend that you invest in a few large funds with stellar historical performance. However, this performance is not guaranteed to continue.

Don’t chase performance; invest for the long term

I cannot stress enough that investors should be mindful of the adage past performance is not a reliable indicator of future performance. What should an investor do? I would build a well-diversified portfolio, based on asset classes and strategies that I believe in for the long term. Invest fixed amounts at regular intervals. And stop letting your emotional response to market movements dictate when you buy or sell. In investing, as is often in life, it can pay to be slow but purposeful rather then fast and flashy. In fact, the fable of the Tortoise and the Hare, where unhurried reliability wins, could well serve as an educational investment text.

Important Disclosure

This is a marketing communication. Please refer to the prospectus of the UCITS and to the KID before making any final investment decisions.

This information originates from VanEck (Europe) GmbH, which has been appointed as distributor of VanEck products in Europe by the Management Company VanEck Asset Management B.V., incorporated under Dutch law and registered with the Dutch Authority for the Financial Markets (AFM). VanEck (Europe) GmbH with registered address at Kreuznacher Str. 30, 60486 Frankfurt, Germany, is a financial services provider regulated by the Federal Financial Supervisory Authority in Germany (BaFin).

The information is intended only to provide general and preliminary information to investors and shall not be construed as investment, legal or tax advice VanEck (Europe) GmbH, VanEck Switzerland AG, VanEck Securities UK Limited and their associated and affiliated companies (together “VanEck”) assume no liability with regards to any investment, divestment or retention decision taken by the investor on the basis of this information. The views and opinions expressed are those of the author(s) but not necessarily those of VanEck. Opinions are current as of the publication date and are subject to change with market conditions. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results. Information provided by third party sources is believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. Brokerage or transaction fees may apply.

All performance information is based on historical data and does not predict future returns. Investing is subject to risk, including the possible loss of principal.

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