A report published by Standard & Poors last month in the US looked at the issue of whether superior performance on the part of a fund manager persists. This is a pretty important topic because many investors of active managed funds tend to look at past performance as a guide to whether a particular fund or manager will do well into the future.
One piece of research evidence used to guild our investment approach for clients places doubt on the issue of fund manager performance continuing. The following is an extract from "Our Research Based Approach" brochure:
On Persistence in Mutual Fund Performance
The Journal of Finance
Mark M. Cahart
March 1997, Vol. LII, No. 1: 57-82
What the paper says: There is no evidence that choosing a managed fund that had outperformed in the past would provide above average returns into the future.
In the author's own words: "The results do not support the existence of skilled or informed mutual fund portfolio managers."
The research clearly showed that just because fund managers out performed in the past did not mean they would continue to do so.
Now some will say that this study was conducted more that 10 years ago and times have changed. So its good that Stadard & Poors produce their regularly updated analysis into the topic.
In their latest publication - Do Past Mutual Fund Winners Repeat? - The S & P Persistence Scorecard the researchers make the following observations:
- Very few funds manage to consistently repeat top-half or top-quartile performance. Over the five years ending September 2009, only 4.27% large-cap funds, 3.98% mid-cap funds, and 9.13% small-cap funds maintained a top-half ranking over the five consecutive 12-month periods. No large- or mid-cap funds, and only one small-cap fund maintained a top quartile anking over the same period.
- Screening out bottom quartile funds may be appropriate, however, since they have a very high probability of being merged or liquidated.
In layman's terms what they found was that just because a mutual fund (termed managed funds in Australia) out-performed previously does not mean it will continue to do so. However, if a mutual fund under-performs badly in past periods it may be worth avoiding this fund as there is a high likelihood the fund won't exist in the future.
These are results from the US but as we see time after time the experience here in Australia tends to reflect the same results.
In conclusion, if you feel like using actively managed funds is the way to go in building your investment portfolio (not the recommended action of this firm) then be very careful using past performance as the key selection determinant.
A better approach in my opinion is to focus on the key determinant of future return - asset allocation - and build a portfolio that minimises risk through broad diversification.
Regards,
Scott Keefer
