Past Perfect, Future Imperfect

You must have often heard parents lament how their once dutiful children went astray after going to college. Kids who were well-behaved and studious in their school years suddenly seem to go berserk as soon as they hit college, leaving the poor parents bewildered. Same kids, radically different behavior. It’s unfortunate that children, unlike investments, do not come with the warning, ‘Note that past performance of a child is not indicative of future performance’.

 Anyone who has invested any money in mutual fund has read a variation of this statement often. While it sounds reasonable for the regulatory authority to demand a similar statement, I wonder what else can one base an investment decision on. Since the future is unknown and the past is known, all investment decisions have to be based on the past. 

No, that’s not meant to be a joke. Take a look at any newspaper, magazine, report, website, whatever. All analysis of future potential is based on the past. This is not wrong, and nor is it avoidable. When I say that this fund is likely to be a good investment, I can only judge it on the basis of its past. Sure, I’ve made some estimates about its future, but those are based on the past. It could be the fund’s past, the fund manager’s, the fund company’s past or whatever, but it’s still the past. 

Clearly, all such estimations are implicitly based on the assumption that the future will resemble the past in a significant way. Past patterns of business--of companies, consumers, markets and economies--will in some way be useful in predicting the future.

Or at least, that’s what we believe. Is this belief justified? To answer that question, we should go back to our innocent schoolchild who went wild as soon he entered college. When the environment that drives behavior changes radically, then all bets are off. 

That’s the point at which the past becomes history and the future unknown. When we look back at the history of Indian businesses over the last few decades, this point proves itself. We’ve lived through times of great change. Moreover, the change has come in waves. Whenever a wave has come, past performance of businesses has become almost irrelevant to the future. Just fifteen years ago, the idea that Infosys would be a more important business than Hindustan Motors (a Kolkata-based auto company that may still be making cars) would have seemed bizarre. Just 16 years ago, there was a massive stock market boom in which one of the starring roles was that of Premier Automobiles (a Mumbai based auto company that definitely does not make anything anymore).  

Why were investors so excited about these companies in 1992? Because they didn’t realize that the economic reforms that had just started would change India. The past was no longer a reasonable guide to the future. Indians would stop buying half-century old car designs and the world would start buying software services from Indian companies. The year 2003 was probably another such break with the past. In practical terms what that means is that both these years were choke points when the patterns of past performance had trouble extrapolating into the future.  

My feeling is that we are standing at the cusp of another such break with history, one that may be far stronger than the one in 2003. From small domestic factors to big global ones, almost everything is in a state of great flux. Don’t be surprised if the pre-2008 past turns out to be a poor guide to the post-2008 future.