“The large print giveth,” Tom Waits once sang, “and the small print taketh away.” Perhaps nowhere is this idea better exemplified than in the investment industry’s most frequently deployed warning: Past performance is not a guide to future returns.
It’s sometimes tempting to think this cautionary maxim – or one of its many variants – is inserted here, there and everywhere merely to keep compliance departments happy. What we mustn’t overlook, of course, is that it also happens to be true.
A strong track record really is no guarantee that a company will carry on doing well. Assorted collapses, crashes, bubble bursts and other unpleasant surprises have repeatedly underlined as much.
Despite this, the reality is that countless investment decisions are firmly rooted in a belief that past performance is a guide to future returns. Not least in light of increasing disclosure requirements, projections based on available data are very often the weapon of choice.
There’s a school of thought which holds that the rise of artificial intelligence can only strengthen this approach. Proponents say quantitative analysis will keep getting faster and more sophisticated as AI’s ability to gather and process information improves.
Yet such a view rather assumes data alone always tells the whole story. In our experience, especially in a complex market like Asia, there are many instances in which this isn’t the case.
The uncomfortable fact is that even the swiftest and most cutting-edge quantitative analysis imaginable may prove wide of the mark if the information on which it’s based is inadequate, open to misinterpretation or misleading. This is why, with the AI age unfolding at pace, we feel direct engagement could be more important than ever.
Highly informative… or largely irrelevant?
In our corner of the investment universe, Asian smaller companies, it’s common for investment teams to operate from a distance. In identifying the businesses worthy of inclusion in their portfolios, many rely on quantitative data and research by third-party analysts.
It’s imperative to acknowledge this can bring success. Investors might earn a perfectly acceptable return from, say, a passively managed, quant-driven index fund. But there are some potential drawbacks to consider.
First, many smaller companies – whether in Asia or elsewhere – undergo little or no third-party analysis in any event. The numbers may well be out there, but they’re not necessarily being crunched by all and sundry.
Second, there are various circumstances in which those same numbers may provide a less than definitive snapshot – even after AI has worked its magic. This is the stuff of GIGO – garbage in, garbage out – and the threat of irrelevance.
By way of illustration, take an organisation that finds itself at a crucial inflection point. It might be embarking on a major restructuring, heading into a new phase of its business cycle or in the midst of a significant management shake-up.
The company could have decades of excellent performance behind it. But if the inflection point is problematic – if the restructuring is ill advised, if the cycle is notably challenging, if the new management team has no clear plan for the way forward – then former glories may count for nothing.
Similarly, the business’s recent history might paint a dire picture. But if the inflection point is geared towards something more constructive – if the restructuring is shrewd and farsighted, if the cycle is eminently conducive, if the new management team has a brilliant strategic vision – then all the dismal data from yesteryear needn’t constitute an instant turn-off.
Strengthening the case for qualitative insights
This is where an on-the-ground presence can make a difference. We regard “being there” – developing an in-depth understanding of places, people, policies and practices – as essential to the task of selecting stocks capable of delivering long-term growth.
This isn’t to suggest quantitative analysis has no merit at all. Nor is it to imply the power of AI should have zero bearing on stock selection. Rather, the aim here is to stress the likely value of adding a genuinely qualitative layer to the investment process.
Particularly in emerging markets, a first-hand glance of what happens “backstage” can be extremely revealing. It’s fascinating to discover whether the image a company projects accurately reflects what’s taking place behind the scenes.
Maybe above all, face-to-face dialogue is hard to top. Meeting with executives and posing probing questions can go a long way towards determining whether a business’s past offers any guide whatsoever to its future.
As active managers, we see direct engagement as a key means of uncovering Asia’s hidden gems. Equally, it can play a big role in helping us recognise apparently promising opportunities as something altogether less appealing.
With technology progressing in leaps and bounds, it’s perilously easy to surmise that artificial intelligence has rendered investing uniquely straightforward. In some ways, sure enough, it has made investors’ lives easier – and it will very likely continue to do so.
We shouldn’t, though, be fooled into thinking AI is the be-all and end-all, less still a cure-all. Ultimately, the arguments for direct engagement may be bolstered, not weakened, by AI’s relentless march.
Xin-Yao Ng is co-manager of Aberdeen Asia Focus plc. The views expressed above should not be taken as investment advice.