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Dispatches

No Long-Term Link Between Past and Future Fund Performance

no-long-term-link-between-past-and-future-fund-performance

Relying on long-term performance will not help an investor select better mutual funds. Beyond periods of one year, there are no clear signs that past outperformers will continue to beat their peers. One-year returns can, however, reveal which funds are benefiting from the underlying price momentum of the stocks they hold for certain categories.

Morningstar looked at the returns of actively managed funds as of the end of 2014 to determine if there is any persistence in mutual fund returns and, if so, what might cause it. They grouped funds into one of five quintiles based on one-, two-, three-, four-, five- and 10-year performance. The analysis used rolling periods starting in December 1996 for all but four of 14 fund categories. Starting dates between December 1999 and December 2001 were used for small growth, world stock, diversified emerging markets and world bond categories.

Funds whose returns ranked in the top quintile (20%) for their respective categories tended to beat their average peers over the following 12 months. The outperformance was found to be statistically significant for only five categories, however: intermediate-term bond, small blend, world bond, world stock and diversified emerging market. The link between outperformance during two-, three-, four- and five-year periods and future outperformance was found to be much weaker for all categories. There was some evidence of persistence for 10-year periods, but the data is influenced by survivorship bias. The weaker performers tended to be closed or merged into other funds.

In discussing the data, Morningstar bluntly stated, “differences in returns across funds do not provide sufficient evidence of skill.” Rather, they found the price momentum of the underlying stocks had a statistically significant effect on performance over one-year periods across equity fund categories. A greater weighting on smaller versus larger stocks also had a statistically significant impact. For the five- and 10-year periods, a preference for more volatile stocks had a significant, but small, impact on returns. Bond fund returns were less consistently influenced by any one factor.

As far as what works, outperformance over one year does show some signs of persisting over the short term. Over the long term, expenses matter, with low fees significantly increasing the odds of success.

Source: “Performance Persistence Among U.S. Mutual Funds,” Alex Bryan and James Li, Morningstar Manager Research, January 2016.

Discussion

Ronald Stasiak from CA posted over 10 years ago:

Your correct,that past performance doesn't predict future performance.But a old friend once told me,when talking about Horse Racing,that the fastest horse doesn't always win,but that's the way to bet!


R Thornley from AK posted over 10 years ago:

This says to use one year returns to predict future returns. But Mark Hulbert said use 10 year returns to find over-performance. Has anyone resolved the contradiction? By the way, what happened to cause the abrupt discontinuance of the Hulbert Financial Digest? Does anything replace it?


Charles Rotblut from IL posted over 10 years ago:

There is research showing a momentum effect regarding stocks: Stocks whose annual and 26-week relative price returns rank within the top 60% of all stocks tend to continue outperforming over the next 12 months. To the extent that a fund stays allocated to those stocks, its performance should benefit. Mark Hulbert ended his newsletter on MarketWatch in February. In his final issue, he wrote, “The world today is a lot different than it was in 1980, when my goal of independently tracking investment advisers’ performances was downright revolutionary. In today’s world, in contrast, awash as it is in Big Data, it seems to be less needed. That, at least, is the judgment of the market.” Mark will continue writing commentary for the MarketWatch website. -Charles


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