At some point, investors shopping for mutual funds or exchange-traded funds typically look at past performance. They hope that a fund that has done better than its competitors over a given period may beat them in the future as well, though that’s not guaranteed.
But what period should you look at? There’s a wide choice from the past month or quarter to the past 12 months, year-to-date, three years, five years, 10 years or during the fund’s entire existence.
You may also see something called a rolling period. It might be five- or 10-year periods beginning every year back to the fund’s founding or some other starting point.
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“When constructing a portfolio, we look at five- or 10-year rolling periods, because we’re looking for consistency of returns,” says Matt Ahrens, a financial advisor with Integrity Advisory in Overland Park, Kansas. “One year of fantastic returns can have a lasting impact on the 10-year performance number, but if you look at how frequently a manager is beating their benchmark in rolling periods, you will get an idea as to how consistently you can expect them to perform.”
As for-profit companies, fund firms like to put the best face on their performance, resulting in the oft-criticized practice of cherry picking data. If the fund did better than average over the past 12 months but was worse than average over the 10 years that included the financial crisis, the marketing materials are likely to highlight the more recent results.
Long-term results are often more meaningful than short-term results, since they are more likely to show the fund manager’s success during market ups and downs.
One problem with using fixed performance periods like the past three, five or 10 years is that this assumes the investor bought the fund at the start of the period. In fact, many investors add money over time, says Joshua Wilson, chief investment officer at WorthPointe Wealth Management in Dallas.
This is where rolling periods come in. They look, for example, at how the fund has done over every five-year period. But instead of looking at 1990 to 1995 and then 1995 to 2000, the rolling-period approach would look at 1990 to 1995, 1991 to 1996 and so on.
This produces more periods for comparison while still covering long periods that span different market conditions, and it also smooths bumps in the road, since more than one rolling period would cover a unique event like a market spike or crash.
It’s a good sign if the fund has beaten most of its peers during most of the rolling periods studied.
“A fund with a 15-year track record has only one three-year trailing return, but has many rolling three-year time periods over the course of that 15 years,” Wilson says. “Looking at a rolling return allows me to weigh how the fund performed from, say, April of 2005 through March of 2006.”
Lou Cannataro, partner at Cannataro Park Avenue Financial in New York City, says rolling periods can provide a deeper look at performance than fixed periods.
“A fund could have a good 15-year average track record but really made all of its growth in the first or last five years,” he says. “The rolling time periods show you the granular details of how the fund managers performed during specific time periods. You can see the performance of the fund and compare to how it performed during periods of market turmoil and surges. You can see the manager’s average returns over many time periods.”
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“Rolling periods are a good way to communicate how an investment performs during longer cycles generally, and can also help compare your strategy to competition,” says Dan Sondhelm, CEO of Sondhelm Partners, an Alexandria, Virginia, firm that advises asset managers.
Rolling periods help minimize distortions caused by special events like the oil crash and tech bubble, he says.
“It’s impressive to say a firm has outperformed the benchmark during 80 percent of rolling five-year periods since 1942,” he says.
A key worry for investors is that a fund may do well in an average year but have some big ups and downs. Those plunges are especially hazardous for the investor who must make withdrawals for college, retirement or some other purpose that cannot be delayed. By looking at rolling periods, you can see how often plunges have hurt the fund’s investors, says Scott Stratton, president of Good Life Wealth Management in Dallas.
“Rolling returns is simply a way to consider what range of returns investors have received when held for five or 10 years,” he says. “I prefer the 10-year figures, because that will generally include both up and down years, whereas the five-year rolling returns will exhibit much more volatility depending on those particular years.”
Though rolling periods are valuable, David Twibell, president of Custom Portfolio Group in Englewood, Colorado, says it’s useful to look at rolling and fixed periods together.
“That works out well since we can then discuss why performance may differ using these methods,” he says. “For example, reviewing how a portfolio performed during 2008 can provide insights into risk management issues, while looking at five-year rolling period returns can put a bad year, like 2008, in perspective by reinforcing the idea that over time the losses experienced in any particular year can be overcome if you avoid panicking and stick to your investment plan.”
No look back can guarantee future results, and any fixed or rolling period chosen can be misleading, says Michael Miller, CEO at Northstar Risk Corp. in New York City and author of “Mathematics and Statistics for Financial Risk Management.”
“Should we be using historical data at all?” he says. “When we use historical data to make investment decisions, we are assuming that, in the future, markets are going to behave pretty much the way they did in the past. Maybe not exactly the same, but similarly. There may be times when using historical data is inappropriate.”
Markets are occasionally roiled by events so unique the past has nothing similar, he says.
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Still, investors have to look at something, and are wise to select a rolling period that matches their expected holding period. If you’re 10 years from tapping your fund for retirement, use a 10-year rolling period, for example.
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Why Pros Use Rolling Periods originally appeared on usnews.com
