The Virtues of Consistency

hat are the virtues of consistent performance? Obviously, there is no virtue in consistently bad performance. Conversely, an investment asset that delivers consistently good performance is analogous to the Holy Grail. But, in what specific ways is consistency of performance valuable and how is consistency of performance to be measured?

In this article, consistency of performance is measured two different ways. In the first approach, the arithmetic mean and standard deviation of the one, three, five, and ten year annualized returns is calculated. The second approach calculates the arithmetic mean and standard deviation of multiple, three-year rolling returns.

The first approach first. An example is shown in Figure 1 using two funds (T. Rowe Price Capital Appreciation and Janus Twenty) that have dramatically different levels of performance consistency during the 10 year period ending December 31, 2004. Both funds have a similar 10 year annualized return, but their year-to-year performance was very different. All the data in this analysis were extracted from Morningstar Principia.

The standard deviation of the four returns (1, 3, 5, and 10 year annualized returns) for Janus Twenty was over 17 times larger than for T. Rowe Price Capital Appreciation. In addition, the mean of the four return figures for Janus Twenty (8.14%) was over 40% smaller than the mean for Capital Appreciation (14.24%). The figure in the last column of Figure 1 is the mean of the four returns divided by the standard deviation of the four returns. This is a simple risk/return measure in which the larger the quotient the better. This risk/return measure also rewards funds that have consistency at higher return levels.

The performance data in Figure 2 reveal the amount of volatility in the annual returns of each fund, which of course, produce the observed differences in performance consistency between the two example funds. The five year annualized return (at the end of 1999) for Janus Twenty was well ahead of Capital Appreciation, but, five years later, their respective 10 year returns were essentially identical (13.95% for Capital Appreciation and 13.81% for Twenty).

Interestingly, over the ten year period (1995-2004) a monthly $100 investment into Capital Appreciation had a terminal, pre-tax value of $23,875 (or a 12.5% annualized return). The same monthly investment into Janus Twenty had a pre-tax ending account value of $18,086, equating to a 7.7% annualized return. Thus, in this particular time frame, a specific virtue of performance consistency manifested itself in a "dollar-cost averaging" scenario. Such a potential virtue is of no small consequence considering the enormous amount of money invested monthly into tax-deferred plans (401(k), 403(b), etc.).

However, Janus Twenty was the superior choice in a 10 year withdrawal mode scenario. Assuming an initial investment of $10,000 on January 1, 1995 with subsequent withdrawals of $100 per month, Janus Twenty had a remaining account value of $19,100 compared to $13,319 for Capital Appreciation by the end of 2004. The high returns in the early years of the withdrawal period gave Janus Twenty the advantage.

Figure 1. Different Paths

U.S. Equity Fund	1 Yr Return	3 Yr Return	5 Yr Return	10 Yr Return	Mean of 4 Annualized Returns	Standard Deviation of 4 Annualized Returns	Mean divided by Std Dev
T. Rowe Price Capital Appreciation	15.29	13.30	14.40	13.95	14.24	0.84	17.03
Janus Twenty	23.89	5.66	-10.81	13.81	8.14	14.67	0.55

Morningstar Principia data as of December 31, 2004

Figure 2. The Annual Beat of Different Drums

The second technique chosen for measuring consistency of performance involves calculating three-year rolling returns (where each three year rolling return is calculated as a geometric mean). In this particular ten-year period from 1995-2004, there were eight three-year returns (the first one starting at year-end 1997) as shown in Figure 3.

The average three-year rolling return for Capital Appreciation was 112 basis points smaller than Twenty's, but the volatility (as measure by standard deviation) of the rolling returns for Twenty was nearly 11 times larger. All of this translates into a return-to-risk score of 4.68 for Capital Appreciation, which is significantly higher than the .47 score for Janus Twenty.

Thus, by either measure of consistency, Capital Appreciation emerges as the preferred choice during this particular 10 year period (all other considerations being equal). But, this analysis is not intended to simply target these two particular funds. Their differences are well known. They were selected to illustrate these two specific measures of consistency.

Figure 3. Three-Year Rolling Returns (%)

	1997	1998	1999	2000	2001	2002	2003	2004	Ave of Rolling Returns	Std Dev of Rolling Returns	Mean divided by Std Dev
T. Rowe Price Capital Appreciation	18.50	12.81	9.58	11.43	12.98	10.64	11.63	13.30	12.61	2.69	4.68
Janus Twenty	31.21	42.20	54.78	24.55	-7.60	-28.63	-12.32	5.66	13.73	29.06	0.47

Now, having introduced two consistency measures, let's take a look at which funds emerged as consistency kings.

Among 1,144 non-redundant, U.S. equity funds with at least a 10 year history, the ten funds with the most consistent performance over the past 10 years (as of 12/31/04) are shown in Figure 4. Both consistency measurement techniques were employed, after which funds were ranked by the return/risk quotient obtained in each measure. Finally, the two rank scores were summed (the lowest possible score being 2). Just as in cross-country, the funds with the lowest summed scores were the consistency winners.

From among 265 non-U.S. equity funds with at least 10 years of performance history the 10 most consistent funds are listed in Figure 5. The top 10 taxable bond funds (out of 567) are shown in Figure 6. Finally, the 10 most consistent U.S. municipal bonds funds (out of 627) are reported in Figure 7.

Clients are more likely to "stay the course" if the performance of "the course" is more consistent. And staying on course is the greatest virtue of all.

Figure 4. Ten Most Consistent U.S. Equity Funds (as of 12/31/04)

Figure 5. Ten Most Consistent Non-U.S. Equity Funds (as of 12/31/04)

Figure 6. Ten Most Consistent Taxable Bond Funds (as of 12/31/04)

Figure 7. Ten Most Consistent U.S. Municipal Bond Funds (as of 12/31/04)