If you are confused by the title of this week's Greenthought$, don't be concerned.  You'll figure it out in a minute.  
 
                 A           B        C
2003      -23.0       24.4      0.3  

2004       34.6       13.9      19.1
2005       6.2         12.3      6.3
2006       10.4       10.8      8.6
2007       14.5       16.4      20.6
 
 
Take a close look at the table above, which contains annual percentage returns of three investments. Now, let's play a short game.  Assume that you are going to choose one of these investments for the majority of your portfolio.  You know nothing else about the investments, so you have no choice but to base your decision on the performance over the past five years.  Since past performance is not necessarily a guide to future performance, we trust you will never actually try to limit yourself like this in real life.  OK, with that  disclaimer out of the way, its back to our game.
 
Which would you choose and why?  To help you decide, here is a quick analysis from us, based simply on the numbers you see in the table:
 
Investment A - has been the most volatile, and showed the potential to post big losses as in 2003.  It also had the highest single year return.
 
Investment B - has been the steadiest of the three, reaching double-digits each year.
 
Investment C - has managed a gain each year, but has only returned over 10% twice in the five year period.
 
So, which one would you pick and why?
 
Now, here is something you may not have realized.  All of these investments are the same.  They are all one-year returns for the S&P 500 Stock Index...What?!  How can that be?  The returns are completely different!  Let me explain.
 
Investment A is the return of the S&P 500 from February to January of each year, starting in February of 2002 and ending in January of 2007.  For instance, A's return for 2003 is the year ending January 31, 2003.  Investment B is the return of the S&P 500 from October 2002-September 2007.  Investment C is the return of the S&P 500 from July 2002-June 2007. 
 
In other words, depending on which month in 2002 you started your investment, the returns from one anniversary of that investment to the next may be completely different.  Put another way, there are 12 different "annual" returns each year for any index, fund, stock, etc.  Given the obsession by the media and many investors with analyzing returns only by full calendar years (i.e. January 1 - December 31 of any given year), you could say that you are only getting 1/12th of the information you need to analyze an investment's past returns!
 
A table or graph that shows each of the 12 month returns (February-January, March-February, April-March, etc.) is referred to as an analysis of "Rolling Returns."  In this example, it's a 12-month rolling return analysis we are talking about.  Depending on how high-powered your analytics tool is, you can run rolling return analysis for 3 month, 6 month, 5 year, 10 year or any other period.  In each case you are looking at many different overlapping periods, not one complete period followed by the next complete period. 
 
More importantly, if you did have this information available to you, how would it help you?  Particularly if you see rolling returns in a graph, you can quickly see the tendencies of an investment to reach returns of different levels.  One thing we look for in any mutual fund we buy is how often its rolling 12-month return has crossed into negative territory and for how long. 
 
If the stock and bond markets gyrate up and down and an investment shows a historical ability to not gyrate with it, that is one very positive point about the investment (of course, it is only one part of the analysis).  To summarize, a rolling return graph helps you characterize an investment's historical nature as slow-and-steady, hit-or-miss, or something else.
 
It is a shame that the investment advisory industry does not place more emphasis on rolling returns.  Given the more even mix of up and down markets during this decade as compared to the 1980s and 1990s (which were dominated by positive returns in all major stock and bond indexes), we hope this will change. 
 
We at Emerald have done our part, as each of the published performance summaries on our strategies contains a graph of rolling 12-month returns.  So, if you want to see an example rolling returns, request these summaries by clicking on REQUEST PERFORMANCE SUMMARIES in the left margin of this newsletter.  That will bring up an email window to Medon Michaelides at Emerald, who will supply the information to you.  We update these reports monthly, so you can also request to be added to the distribution list if you like.
 
There is no law in investing that says you stop analyzing past performance after you have checked the calendar year returns and returns over trailing periods (past 3 years, past 5 years, etc.).  Rolling returns, if you can get the data in that format, are even more valuable than all of that.  So, roll 'em if you got 'em!
 
 
The preceding article is not a complete analysis and should not be considered investment advice.  Emerald Asset Advisors, LLC is a registered investment advisor.  If you would like to receive more information about Emerald, please contact us for a copy of our disclosure document, Form ADV Part 2 and Schedule F.

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