Five Year Returns
(adapted from the Dragonfly Fund Quarterly Update - December 2019)
Stock performance is rarely linear with ebbs and flows through time. Equitable Investors is focused on the medium-to-longer term window and while very conscious of managing volatility, fully expects there to be good and bad interim windows for investment performance.
We are fans of the question posed by quantitative investor Wesley Gray, PhD, author of Quantitative Value, several years ago: “If God is omnipotent, could he create a long-term active investment strategy fund that was so good that he could never get fired?” The answer was that God would get fired. Not because God would be a bad investor, of course, but because picking the investments that would deliver top decile (top 10%) returns over five years then sitting back and waiting would mean that God’s clients would have to hold their nerve in the interim period when the “perfect foresight” portfolio suffers drawdowns of as much as 76%.
Equitable Investors has maintained an interest in the distribution of returns across the equity market over time and take such historical evidence into account when assessing the probabilities of success or failure for investments in Dragonfly Fund. We have updated our analysis of five year total returns on the ASX through to mid-January 2020 and the figures can be summarised as follows (using data from Sentieo) and in Figure 7 (below):
- Positive skew | across 476 stocks stocks with the required data (excluding resources, REITS, biotech), 63% delivered a positive return over five years v 37% declining in value
- Cost of equity | the average annual return was 7.0% (the median was 6.8%); given a five year risk-free rate of 2.03% in January 2015, this implies a 5% equity risk premium, as we would expect - this is precisely in-line with the Dragonfly Fund’s performance benchmark of the five year bond rate + 5%!
- “Fat tails” | 19% of stocks returned at least 100% while 21% lost at least half their value
- Drawdowns | stocks in the top decile of returns for the period had an average decline in value (using monthly price data) of 33% (see Figure 8, below)