A few days ago, Temasek published details of its investment performance. Temasek reported that it delivered a 24.5% shareholder return in the past financial year. I saw some interesting comments in the forum. Some people say the Temasek manager is lousy, his average return is better; some say by just investing in S&P 500 ETF, he can outperform. It is understandable because most people have a vague understanding of the “investment return” and its implications. So I thought it would be useful to discuss this topic.

Very often, people ask me, “What is your average return?” If you are serious about understanding an investment strategy, it is often the wrong conservation to start with.

An investment performance number sounds like a very fair and objective measurement, but it is often misrepresented. People often say a “number doesn’t lie”, but they forgot another phrase “Lies, damned lies, and statistics”.

Let’s zoom into these numbers.

#1. The “average return” is one of the worst performance metrics

To most people, investment return means “average annual return”. In fact, the majority are only talking about “arithmetic average annual return” because it is the easiest form of return calculation. Unfortunately, the average return is the worst metric to use to gauge and compare an investment strategy or fund manager.

Let me explain. The average return is exactly what it says, an average of a few years of returns. For example, a two-year “arithmetic average return” is calculated as ½ * (year 1 return + year 2 return).

Now think about it. If a person tells you that his investment or his fund made an average return of 25% return per year, does it sound impressive? Surely yes right?

Now think a little more deeply about it. If you start your investment with $50,000 and it grows 100%, you will end the year with $100,000. If in the following year, your portfolio suffers a 50% drawdown, you will return to your original capital of $50,000.

So, over the two years, your total return is 0%, right?

But by definition, you have actually made an average return of 25% per year, ½ * (100% + (- 50%)) = 25%. Do you still think it is a good performance?

The thing is, this technicality is exploited by some (if not many) unscrupulous investment trainers, bloggers, social media marketers and even some investment professionals to misrepresent an investment strategy or product, mainly to attract uninformed investors and maximize sales.

A reputable portfolio manager will never do this. In order to not get fooled, you need to know how to scrutinize an investment performance statement.

#2. Investment performance is more complicated than you think

Let’s begin our analysis. As an example, Temasek uses “total shareholder return” as its performance metrics. In Temasek Review 2021, it published the following information:

Total Shareholder Return (TSR) is a compounded and annualised measure, which includes dividends paid to our shareholder and excludes capital injections from our shareholder. Our TSR over short, medium, and long time periods are a snapshot of our performance.

As at 31 March 2021, our Singapore dollar one-year TSR was 24.53%. Our three-year TSR was 7.29% and our 10-year TSR was 7%.

Our 20-year TSR was 8%, versus the Singapore 20-year annualised core inflation of 1.5%. Longer term 40-year TSR was 13%.

These statements look simple but they contain a lot of complicated details. Most people only focus on the numbers but overlook these details. Here are the things you should pay attention to:

• What financial metrics are used? – Temasek uses Total Shareholder Return (TSR).
• Is the return defined? – Yes, total shareholder return factors in capital gains and dividends and excludes capital injection. (You need to refer to Temasek’s website for more details about the calculation assumptions.)
• Is the return based on a specific period? – Yes, it is annualized as of 31 March 2021.
• Is the return presented in a specific currency? – Yes, it is in SGD. The number will be different if you use other currencies.
• Is the return compounded and annualized? – Yes.
• Is the return consistent? – This is up to your interpretation.

At this stage, we haven’t even talked about the inflow and outflow of the capital and future obligation in terms of accounting. But I want to give you a glimpse of how professionals look at returns.

Additional Reading: Investing the GIC way – How to ride out and profit from a global pandemic crisis.

Temasek has demonstrated that sticking with a sound investment strategy is crucial to riding out multi decades of booms and dooms.

#3. There is no perfect return metric

In fact, even the “Total shareholder return” is not a perfect measure (none of the performance measures is). For example, TSR does not reflect the actual dollar returns and it is arbitrary due to the book closing date.

In hindsight, we know that 31 March 2020 was just after the stock market crash. The global stock market made a V-Shape recovery and had a stellar run for the following year. So a 24.53% return is not that fantastic after all for this period.

But you need to consider Temasek’s investment mandate which is very different from a US stock market index. For example, consider Temasek’s Asia focus, desire for stability, and mission to support local enterprises.

We can also understand the so-called “underperforming S&P 500” (as commented by some netizens) was due to Temasek’s bullish view on China, whose stock market crashed in February. Should the Chinese government goes easy with antitrust regulation and crackdown of many industries, China stock market may have done better. In fact, China stock market does perform better in 2020 comparing to S&P 500. So it is just a matter of reference date.

We also need to consider the size of Temasek’s value. It is at $381 billion now. Every 1% movement of the portfolio is $3.8 billion in cash. It is a totally different ball game compared to a personal portfolio.

Let me summarize…

I hope this article gives you a new perspective of how to look at the word “return”. Here is my advice:

• Don’t ask about the average return of an investment strategy or portfolio without specification.
• Don’t compare returns without understanding the underlying assumptions.
• Dollar return is more important and meaningful than percentage return. A 5% return on $100,000 is better than a 100% return on $1,000.
• Take return numbers with a pinch of salt.

After all, past performance does not indicate future performance, believe it. Different strategies and asset allocations perform differently in a different market environment.

Having said that, it is not that investment performance numbers are not important. It is the interpretation of the numbers that is more complicated.

In a previous article, I shared with you how to do a quick analysis of a single stock. In my next article, I will explain how to evaluate the performance of an investment strategy or fund. Stay tuned…

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