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  • Writer's pictureAndile Khumalo

Why We Can't Bank On The Past When Investing For The Future

Updated: Oct 13, 2019

Wits University recently hosted Brian Joffe, the former CEO and founder of Bidvest and now CEO and founder of Long4Life, for a conversation around the profession of chartered accountancy and entrepreneurship. Though I was supposed to be a panellist in the debate and presumably have something intelligent to add to the conversation, I spent most of the time drawing from Joffe's years of wisdom and insights. He made a number of important points about entrepreneurship and what he has learnt over the years. However, his articulation of the role of accountants and how they can better serve the world made for some scrumptious food for thought.

In a room full of accounting students and lecturers, Joffe asked: "What do you think accounting actually is? What do you think accountants actually do? You are historians. You record history. We essentially record the history of what's happened and we have the methodologies to record that history. I don't think historians equip anyone to understand what's likely to happen in the future, unless of course you believe that things just happen again and again the exact same way. I don't think the world we live in today is anything like the world we lived in before, I don't believe that the world of tomorrow will be the same as the world of today."

His line of logic got me thinking about just how much, especially in investment decisions, we analyse and reach a conclusion based on history. When you are looking to acquire a business, what do you ask for first? The previous three or five years of financial statements. When you want to invest money with a fund manager, what do you look for? The ranking and percentage returns they have delivered to clients over a period. When we want to employ someone? We ask for their CV and ask them all sorts of questions about their roles in previous jobs.

Why are we so obsessed by past performance as an indication of future behaviour?

In his article "Making decisions based on past performance works (except when it doesn't)", Vanguard Group's Shyam Yekanath uses a powerful illustration to explain our behaviour.

"Shortly after the 2018 Winter Olympics closing ceremony, I started thinking about the 2022 Winter Olympics. Will Russia dominate figure skating? Will Norway and Germany win the most medals? My questions reflect a deep-rooted acceptance that past performance is key to forecasting future events. Drawing on past performance to make inferences about the medal count in future Olympics is a logical approach you can apply to other events too, like picking a restaurant. It's true that basing your present-day decisions on past performance works in some situations. But that doesn't make prognostication a reliable strategy for choosing your investments," says Yekanath.

"The factors that affect investment outcomes, such as market volatility, political and economic climate, and expectations around company or sector performance, are cyclical and random."

When we want to make investment decisions, we have access to all sorts of historical information such as rankings, ratings and historical returns, but, as Yekanath observes, "research shows that top-performing funds rarely make it to the medal podium twice".

The reality is that accountants will always be historians. Someone has to do it. However, with the complicated reporting standards we have, many people are able to hide many things in many places.

Perhaps it is time we simplify our financial reporting standards - if only to ensure that the historians tell the correct history. Then at least some of it can be useful for the future.

This article first appeared in the Business Times section of The Sunday Times on 29 September 2019.

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