Historical return analysis

Definition

Historical return analysis is the process of evaluating the past performance of an investment or a portfolio by examining its historical returns over a specific period. This analysis helps investors and analysts understand how different factors, such as market conditions and company size, have influenced returns, allowing for better predictions about future performance. By comparing historical returns across different investments, this method can provide insights into risk and potential rewards, including the identification of size premiums.

5 Must Know Facts For Your Next Test

1. Historical return analysis often utilizes data from multiple years to assess patterns and trends in investment performance.
2. It can help identify whether an investment consistently outperforms or underperforms relative to its benchmark, providing insights into management effectiveness.
3. This analysis is crucial for understanding size premiums, as smaller companies may exhibit different historical return patterns compared to larger firms.
4. Investors use historical return analysis as a key tool for making informed decisions about asset allocation and portfolio management.
5. It's important to remember that past performance does not guarantee future results, and historical return analysis should be used in conjunction with other evaluation methods.

Review Questions

• How does historical return analysis assist investors in understanding the impact of size on investment returns?
  • Historical return analysis helps investors see how different sizes of companies have performed over time. By examining the returns of both small and large firms, investors can identify trends that suggest smaller companies tend to have higher expected returns due to the size premium. This understanding allows investors to make more informed decisions about including smaller companies in their portfolios based on historical performance.
• Evaluate the significance of using historical return analysis when assessing the potential risk-adjusted returns of an investment.
  • Using historical return analysis is vital when evaluating potential risk-adjusted returns because it provides a clear picture of how an investment has performed in relation to its risk profile over time. By analyzing past performance, investors can determine if higher returns are justified by the level of risk taken. This comparison allows for more accurate forecasting and can help avoid investments that may appear attractive based solely on nominal returns without considering the risks involved.
• Synthesize how historical return analysis integrates with concepts of market efficiency and size premium in investment strategy development.
  • Historical return analysis integrates with market efficiency and size premium concepts by providing a framework for understanding how returns are influenced by information availability and company size. In an efficient market, historical returns should reflect all known information; however, anomalies like the size premium indicate that smaller firms may still offer excess returns despite this efficiency. By incorporating historical performance data into investment strategies, analysts can identify opportunities where size premiums exist, enabling them to capitalize on inefficiencies in the market while also being aware of historical trends that influence potential outcomes.

Related terms

Size premium: The additional return that investors expect to earn from investing in smaller companies compared to larger ones, reflecting the higher risk associated with smaller firms.

Risk-adjusted return:

A measure of return that accounts for the risk taken to achieve that return, allowing for comparisons between investments with different risk profiles.

Market efficiency: The concept that asset prices reflect all available information at any given time, suggesting that consistent excess returns are difficult to achieve.