As often happens with good regulations, the SEC's new requirement for calendar-end performance results came with unintended consequences. It codified the snapshot-in-time anomaly. (Photo: Shutterstock)
There's a demon that exists in all compliance-approved standardized reporting formats. It's terrible, and it can mislead both professionals and retail investors. It's a well-recognized behavioral fallacy that goes by the name of “recency.” It's our awful human tendency to overweight the importance of what we've most recently seen. It's why, when asked to name the greatest actor, more folks say “George Clooney” or “Brad Pitt” than “Humphrey Bogart” or “Jimmy Cagney.”
In investment performance, it's often called the “snapshot-in-time” anomaly. Unfortunately, except for industry insiders, the snapshot-in-time anomaly remains written in regulator's rules. And that's too bad for investors and those who advise them.
Christopher Carosa, CTFA, is chief
contributing editor for FiduciaryNews.com,
a leading provider of essential news and
information, blunt commentary and practical examples for
ERISA/401(k) fiduciaries, individual trustees and
professional fiduciaries.
Here's the compliance conundrum: The SEC now requires all mutual funds to report calendar-end performance results in the mutual fund prospectus. This data must be presented in one, five and 10-year periods, along with a since-inception number. Here, I'd like to focus on the danger of relying on an arbitrary period end date (whether it be calendar year end or any other date).
First, kudos to the SEC for coming up with this requirement. Before this rule, mutual funds got to pick their performance end-date (with most opting for fiscal year end, an artifact that remains in the required mutual fund semi-annual accounting reports). Unfortunately, as often happens with good regulations, this one came with unintended consequences. It codified the snapshot-in-time anomaly.
To avoid the negative consequences of the anomaly, you must first become aware of it. Windows of opportunity to broaden awareness do occur. The best happened at the end of the third quarter in 2013 or calendar end 2013. In both cases, the most devastating performance of the 2008-09 bear market dropped off the five-year reporting charts. Mutual funds went from reporting low single digit or even negative performance to reporting healthy double-digit returns.
Did those mutual fund managers suddenly discover great stocks? No. This was simply the anomaly in action.
More recently (because, remember, “recency” works best with more recent data), we need look no farther back than the end of the second quarter of 2018. The last two weeks of June featured hyper-anxiety regarding the “trade wars.” The market tumbled roughly 3 percent, with the low point being—you guessed it—just about June 30, right in time to be memorialized in the second quarter finance reports.
No doubt, this startled many recipients of those statements. Especially because they likely received those statements a couple of weeks after the quarter ended when the trade war frenzy evaporated and, once again, headlines were trumpeting market growth. “Why are my funds doing so bad when the market is doing so great?” they probably muttered to themselves.
The answer: The snapshot-in-time anomaly. By mid-July, the markets—and probably their mutual funds—had recovered from their June swoon.
This is what I would call a “teachable moment.”
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Christopher Carosa
Chris Carosa has been writing a weekly article and monthly column for BenefitsPRO online and BenefitsPRO Magazine since 2011 and is a nationally recognized award-winning writer, researcher and speaker. He’s written seven books, including From Cradle to Retire: The Child IRA; Hey! What’s My Number? – How to Increase the Odds You Will Retire in Comfort; A Pizza The Action: Everything I Ever Learned About Business I Learned By Working in a Pizza Stand at the Erie County Fair; and the widely acclaimed 401(k) Fiduciary Solutions. Carosa is also Chief Contributing Editor of the authoritative trade journal FiduciaryNews.com and publisher of the Mendon-Honeoye Falls-Lima Sentinel, a weekly community newspaper he founded in 1989. Currently serving as President of the National Society of Newspaper Columnists and with more than 1,000 articles published in various publications, he appears regularly in the national media. A “parallel” entrepreneur, he actively runs a handful of businesses, including a small boutique investment adviser, providing hands-on experience for his writing. A trained astrophysicist, he also holds an MBA and has been designated a Certified Trust and Financial Advisor. Share your thoughts and story ideas with him through Facebook (https://www.facebook.com/christophercarosa/)and Twitter (https://twitter.com/ChrisCarosa).
