Wednesday, June 14, 2006

Statistics, The Funds, Booms and Busts

Firstly: I recently had a comment about high-performing funds.

The short answer: some people get lucky. Nobody hears about the underperforming funds. If you take a consistent definition of "a fund" -- and track them over time without changing it -- and do a real average, then you might get a number you can believe. What's more likely is that some statistically unwise reporter has found 5 or 10 funds which have all been profitable, averaged their results, and gotten an above-average return.

Simple statistics prepared by anyone other than an expert, with anything less than a full understanding of the statistical methods used to arrive at them, do not carry enough meaning to do be certain about their implications.

It's equally possible, for example, that if you take the last three boom years, the average fund return *was* around 17% -- just as it likely was for many individual highly leveraged traders. However, if you extend your period out to the long term (say 15 years) to incorporate some crash periods, the figures will look less rosy.

By all means, consider the value of a fund, but don't place infinite faith in them.

The ASX has recently had its single biggest drop since S11, and has been falling steadily for several days. Yet, considered over only a 1-year period, returns are still in excess of the 10% rule-of-thumb figure mentioned earlier. While there has been a recent plunge, investors are still experiencing long-term rewards. The intensity of the current fall is high, but its duration has been short, and has not had a terrible impact considered over the sufficiently long term. The longer the period of time under consideration, the lesser the impact of extreme events if they can be survived.

To speculate, one reason for the size of the current fall might be that individuals are taking profits. Relatively few people, perhaps, have bought shares at recent high prices, while relatively more, perhaps, are realising 25% profits from purchases made several years ago. Considered against yesterday's prices, there has been a big fall, but many traders will be considering not yesterday's price, but their purchase price. Since traders may own shares for many years, medium-term price history is highly relevant.

While in some senses this seems ridiculous (why would anyone not want to sell at the high, and not be dismayed by the drop), it also makes sense that individuals will be making decisions against profit targets, trading overheads and their own particular strategies. It seems like the better risk to lock in a 25% profit than hope for a return to previously high values to gain 35%. Risk-averse traders would prefer to protect their returns.

Cheers,
-MP
(This is not investment advice. I'm just this guy, you know?)

1 Comments:

Anonymous Anonymous said...

i read your posts every now and then, why arent u updating it anymore

5/17/2007 04:09:00 AM  

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