September 15, 2016

Beware of “Consistent Performance”

We frequently hear fund houses, advisors, even the media talk about certain mutual fund schemes as having given “consistent returns” or having shown “consistent performance”.   In its rankings of schemes, CRISIL has a category called “Consistent Performers”.  But what exactly does being “consistent” mean?  Can scheme returns or performance really be described as “consistent”?

I have come to believe that most people who use the word “consistent” in the context of a mutual fund scheme’s returns or performance, actually misuse the word.  What makes matters worse is that this is a word that is easy to misunderstand.  Thus, through a combination of misuse and misunderstanding, many of those who promote schemes with such a claim are able to convey an impression of good performance even when none exists. 

Till some years ago, I used to ascribe most such claims to ignorance.  But the dubious and widespread nature of these claims has now made me suspicious of any scheme whose returns or performance is dubbed as “consistent”.  An industry insider whom I know, is fond of saying that “it is the best word to use when you don’t have good performance to show.”  In this post, I make the case to be wary of any claims of “consistent” performance or returns, and to not accept such claims at face value.

For returns or performance to be called “consistent” these have to be, to quote the Merriam-Webster’s dictionary, “marked by harmony, regularity, or steady continuity :  free from variation or contradiction(emphasis mine).  Thus, to make a claim of “consistent returns,” the returns should be identical, day after day or month after month or year after year etc.  Is there any mutual fund scheme that can make such a claim?

Performance is different from returns, and the term “consistent performance” gives a lot more latitude.  But even so, in itself, it is a vague description.  For one, it needs to be clarified as to how performance is measured (e.g. returns relative to a benchmark index, quartile ranking etc.)  For another, it needs to be clarified as to how consistency is measured (e.g. it could be day after day, or month after month, or year after year etc.)  The total period over which consistency is measured also needs to be clarified i.e. over how many days/ months/ years. Simply describing a scheme as being a “consistent performer,” therefore, is misleading.

But if all of this is sounding too theoretical, let me offer you a couple of real-life instances of misleading communication that I recently observed.

The first instance relates to one of the largest fund houses by AUM.  In a recent marketing communication, they implied that one of their debt schemes had given better returns than any PSU bank deposit over any 3 year period over the scheme’s 14 year existence.  They highlighted it as “consistent outperformance”.  Prima facie it met the requirement of being adequately clarified, and free from contradiction.  But there was one other problem: the claim appeared too good to be true.

Not surprisingly, when I looked closely, I realized that the data they were using to make the claim, represented just 6 years of the 14 years that the scheme had been in existence.  And when this was subtly pointed out to them, they opted to unabashedly continue with the assertion but without mentioning that the scheme had been around for 14 years.

The second instance relates to an exchange that I had earlier this week with a certain mutual fund salesperson.  He was trying to convince me of the merits of investing in one of the equity funds managed by his fund house.  As readers of this blog would know, I select schemes based on qualitative factors rather than performance.  Regardless, this gentleman was keen to draw my attention to the actual returns of the scheme.  The thrust of his pitch was that if I looked closely enough, I would see that this scheme had delivered “consistent performance” over the years.  As I mentioned earlier, any such claim sets alarm bells ringing for me.  And when someone emphatically pushes such a claim in my direction, as this person was attempting to do, I tend to react strongly.  Luckily for this person, I was in a good mood that day.

So when he made his remarks about “consistent performance,” I responded by saying, “Forgive my ignorance but how do you measure performance?”

He replied, “It has consistently beaten its benchmark index.”

“So you’re saying that it has beaten the index year after year, right?”

“Over the last 1 year, 3 years and 5 years.” 

Any claim of consistency based on trailing returns can be safely assumed to be a deception.  On any other day, I would have halted this person in his tracks and compelled him to consider that either he didn’t know the definition of “consistent” or else he was lying.  For good measure, I might have even pulled out a dictionary and read out the definition aloud.  But that day, as I said earlier, I was in a good mood.  I took a few minutes to check something on my laptop, before replying. 

“Well, it seems that this scheme gave less returns than the index in 4 of the last 7 calendar years.”

He appeared adamant.  “But it has beaten the benchmark over the last 1 year, 3 years and 5 years.”

“So it has.  But that’s because of end-point bias,” I said politely. 

He did not seem to be aware of that term.  Worse, he chose to hide his ignorance by holding his ground.

“That may be, but the performance is still consistent.”

This is where I lost it.

“If it has given better returns than that index in only 3 of the last 7 calendar years, then how the f**k can you call it ‘consistent’?”

The forcefulness of my response put him on the defensive, and he chose to retreat.

“I’ll need to check and get back to you.”

I don’t expect to hear from him anytime soon.

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