Concorde 2000: Imprisoned by Recent History?

You have surely read articles which present China as a superpower by 2050, which is going to be far the biggest economical power, not to mention India, while the USA and Europe will remain far behind them. These things are usually demonstrated also with beautiful charts, as you can see one of these here. What comes to your mind when reading these writings?

I usually think that, although there is a one percent chance that the world in 2050 will look as it is projected now, but there is a 99 % chance that it will be completely different. Who knows whether in 2050 the USA or China will exist in their current form? Or we will be foreseeing the rise of another country? It is very bold to make a forty-year forecast about the development of the world, because there is an endless number of factors which will influence the development of these things by that time. The maker of the forecast may see maximum a few of these factors.

In fact the author of these writings has become a victim of a psychic deception without realizing it. This deception is calledrecency bias, studied by psychological science (behavioral finance) for a long time. The point of it is that, because it is very difficult to predict the future, our brain will answer – without realizing it – a much simpler question: what have we experienced in the recent past? In fact, the vision of the future rise of China is decisively based on a single fact: the consciousness of the quick growth in the last 20 years. (Of course, the authors of these articles will not recognize this, they will rather advance several arguments as the basis of the fast growth for the future, which are true in the case of other countries, which do not grow by 10% a year.)

Recency bias has a very important role in the field of investments, as an investment is nothing else than a bet on the future price development of a given asset.Unfortunately a lot of investors make the same mistake as the writers of the forecasts for 2050 do: they deduce the price development of an investment from past accomplishments, thus they prefer those investment assets which have performed very well in the last few years, though in the meantime the given asset might have become overpriced. Recency bias is one of the main generators of bubbles and collapses following them. According to Warren Buffett the majority of investors behave as if they were trying to drive a car forward looking into the rearview mirror.

According to a study made by Dalbar (source: DALBAR Quantitative Analysis of Investor Behavior) between 1988 and 2008 the American S&P 500 index reached an average 8,4% return annually, while the average American equity fund investor made only 1,9%. There were two factors behind these awfully bad results. A smaller part of the underperformance is explained by the fact that the average equity fund performance usually lags behind the index, mainly because of operational costs. But the bad timing of investors was much more responsible for the bad performance: they invested a lot of money in equity funds when these had already performed very well in the past. Peter Lynch, the fund manager of one of the most successful American  equity fund in the 80’s (reaching a fantastic track record as the fund manager of Fidelity Magellan Fund) also lamented that, though his fund had performed very well, its investors had lagged far behind. They were in the right place at the wrong time. Recency bias?

The phenomenon can be easily demonstrated if, in case of a fund we compare time-weighted return to capital-weighted return. The former shows the performance of the fund for the whole period, irrespective of the amount of money in it (which is nothing else than the development of the net asset value of one unit), while the latter takes into consideration the incoming and outgoing flows, so it put greater emphasis on the performance of those periods when there is a lot of money in the fund. So, time-weighted performance reflects the return of an investor who has held the investment units in the fund till the end, while capital-weighted performance shows the average return of the investors (because they have sometimes bought, and sometimes returned some units).

On the occasion of the 15th birthday of Concorde 2000, we have calculated these indicators of the Fund. During its history of 15 years Concorde 2000 has reached an average 12% (time-weighted) performance annually, while the investors achieved only 5,8 % (capital-weighted return). So the difference is similar to the one of the American stock investors. The main reason is that the Fund has reached its biggest size by now on the eve of the great recession of 2008. Since then, due to the outflows, the size of the Fund has become three times smaller than it was before, though the net asset value of one unit is 15% higher than its peak level in 2008. This means that the Fund has done more than making up for its losses suffered during the crisis, despite the bad environment (at the end of 2007 the BUX index (Hungarian equity index) was at about 26.000 points, and now it fluctuates around 18.000 points). The bright side of all is that, compared to an average American fund, Concorde 2000 has outperformed the underlying markets (an average annual outperformance of 4,7% in 15 years), which has compensated investors of the Fund for their bad timing decision, thus their capital weighted return is not so small compared to the performance of the markets.

As far as Concorde 2000 is concerned, it is worth talking about the future as well. Of course we don’t know exactly what the future holds for us, but it may be supposed that recency bias will incline us to make the same mistake again. Over the past 5 years the underlying markets of the Fund have performed quite poorly. The BUX index and the value of the regional CETOP20 stock index is down by one third since 2007. The performance of markets till now has priced in a lot of bad things for the future. The best valuation metric in the long run, I think, is the Shiller-P/E ratio, which is based on average inflation-adjusted earnings for the previous 10 years. The Shiller P/E ratio for the S&P 500 for the past 130 years has been 16,5 on average, while great, long lasting bull markets have started from a ratio under 10. In the case of BUX the Shiller-P/E ratio was 18 five years ago, and it is about 7,5 now, while the CETOP20 index is about 9,5.

This level of Shiller P/E indicates that in the previous five years there has been an enormous decline in the valuation of our region, and the present levels are considered very low. Our country will not be in a recession forever, the listed companies will not always have to pay disproportionately high extra fees, and investments will not always flow out from our region. We hope that in the future our investors can have a bigger share from the yields of Concorde 2000, than in the previous 15 years. But for this we need to overcome recency bias and now cash should be flowing into the Fund, not out of it…