Myth #3: A manager’s track record is a strong indication of future performance

TRACK RECORD INVESTING

Many investors and investment managers rely on guides like Morningstar ratings or the past track record of mangers when selecting the mutual funds they buy. As the following data indicates…

PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS 

Do you think that statement is plastered all over every investment advertisement you see because it is false?

The following is a study of the history of performance track records of mutual fund managers.

This graphic shows that actively managed funds that achieve top performance in one period typically do not repeat their success in a subsequent period.

The stacked graph at left sorts the entire US equity fund universe by cumulative 5-year performance relative to each fund’s benchmark (includes only those funds with a complete return history for the period). As shown, the top quartile comprises 284 funds. The right box shows how these top-quartile funds performed relative to their benchmarks in the subsequent five-year period. The arrows indicate the movement of these top funds across quartiles.

Only 19% of the top-quartile funds repeated their top performance in the subsequent five-year period. Forty-two percent of the funds dropped to the second, third, or bottom quartiles. More significantly, 39% of the original top-quartile funds did not survive the entire period. These top managers, who were perceived as the most skilled in the US equity market, showed no ability as a group to repeat their top-quartile performance. Indeed, almost four out of ten funds did not survive, and the funds that did survive were spread across the sorted universe.

The lesson of this illustration: choosing actively managed equity funds according to past success does not guarantee an equally successful investment outcome in the future.

This graphic depicts subsequent five-year performance of the top-quartile of actively managed US bond funds. The stacked graph at left begins with the 148 funds in the top 25% of performance (relative to their respective benchmarks). The arrows show how these top performers fared in terms of quartile rankings in the subsequent five-year period.

Similar to the equity fund analysis, a low percentage (23%) of the top-quartile bond funds repeated their high performance relative to their particular benchmark, while 35% failed to survive the period. The remaining 42% were dispersed in the second, third, and bottom quartiles.

Although investors may attribute a manager’s top ranking to superior knowledge and skill, these stock and bond fund illustrations suggest that relative performance among actively managed funds is mostly random, and investors cannot use past returns to predict future winners.

Myth #1: We can identify stocks that will go up in the future

Myth #2: We can predict the timing and duration of the market’s ups and downs