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The Best Way is the Simple Way
I received feedback on my article “Understanding Blue Chip Risk” published on 19 Mar 2014 that comparing averages of indices and the use of indices is not representative of the true picture of stock investing. I thought it will be good to share with you some of my thoughts.
The objective of the article was to clarify a simple point – investing in equities, by itself, is risky but blue chip stocks do present relatively less risk than small and mid-cap stocks. To illustrate that, an objective method of comparison has to be employed and that is through statistical data. Indices of the blue chip, mid cap, and small capitalisation companies were also used instead of selecting a portfolio of a few companies to represent the different group to avoid selection bias.
Using averages only to analyse a situation is insufficient as such, the data presented was not limited to averages only. Median was also employed instead to reduce effect of outliers and range (maximum and minimum) was used to show the “success and failures”. Index managers do change the components stocks to ensure that index continues to be a good proxy or indicator of the market’s movement. The act however creates what academics term “survivorship bias”. However, survivorship bias affects the comparison of fund manager’s performance (and also individual stock performance) and indices when the time period for comparison is long – like between 20 to 50 years – but the effect is minimal when the time period for comparison is short.
My previous article compared the three indices between 2008 and 2013. A total of about 5 years and so survivorship bias issue is minimal. Furthermore, the comparison is made between three indices and not between the STI and a few other stocks or funds and so the survivorship bias would have been common in all three – effectively cancelling out the effect.
Are there any other ways to design the study? Well, it is possible to select individual companies or even a set of companies to make a comparison but we would introduce another type of bias – selection bias. That would introduce another world of arguments. The methods employed are not perfect but are sufficient to illustrate the point objectively. We can employ other methods to compare but such methods can be even more complicated or introduce other biases into the comparison.
Keeping it simple is always best.
GET TO THE POINT : Performance measurement is never easy and never draws complete consensus in any one method. Every method has its pros and cons and really is a case of using the most optimal method that minimises the various errors.
Roger Tan is the CEO of Voyage Research, a fully licenced Investment Research House which provide investors with independent and professional insights and analysis on public listed companies. Roger is a guest columnist for Asean Equities Review.
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