The marketing material of fund managers always has the disclaimer “past performance is not an indication of future performance”. If that is the case, then why do research analysts bother assessing the investment performance track record of the fund managers they research? We explain why investment performance track records matter in private markets.

Why “past performance is not an indication of future performance”?

It is certainly true that just because a fund manager achieved X% last year does not mean they are going to achieve X% or similar in the future. It could be materially higher or lower. 

This is because the investment returns achieved by a fund manager are a function of the manager’s investment processes as well as the prevailing economic conditions and investor sentiment. Assuming that the fund manager’s investment processes are unchanged over short time horizons, then the prevailing economic conditions and investor sentiment will drive the short term investment return volatility. This is why past performance is not an indication of future performance, because no one can accurately and consistently predict economic conditions and investor sentiment and adjust their investments accordingly to profit from them.

If past performance is not an indication of future performance, why bother assessing it?

It is not the investment return figures and how positive they are that leads to a favourable assessment of a fund manager’s investment performance. Rather it’s the appreciation of how those investment returns were achieved and whether they are consistent with the investment processes that the fund managers claim to follow that will lead to a positive assessment.

For example, a fund manager may claim that they create value by improving the systems and processes of a company and that they don’t rely on leverage to boost investment performance. But if there is no tangible evidence of improved margins or revenue growth (i.e. an indication that the system and process improvements have led to sustainable cost savings) and that the positive performance of the fund also coincided with expanding revenue multiples, then it would be appropriate to conclude that the positive investment performance was influenced by luck rather than engineered by the fund manager. Such an analysis also works in reverse. That is, the manager’s performance track record would be viewed favourably if there was material evidence of margin improvement or revenue growth, but a contraction in revenue multiples over the holding period overwhelmed those improvements.  

The assessment of a fund manager’s performance track record also provides the opportunity to challenge the manager about episodes of poor past performance. There is great value in getting insights into the lessons they have learned from those periods of poor investment performance, and how their investment processes have improved from those learnings.

So it is not just about the historical investment performance figures. Understanding the performance drivers of a fund and the repeatability of the fund manager’s strategy is what matters most. This is particularly true of private markets fund managers, as they play a greater role in creating value for investors when compared to their listed markets counterparts, who are more susceptible to the whims and sentiment of listed markets.

Of course, however, even in this, past performance is not a reliable indicator of future performance and specific risks may impact on future return.

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