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Dispatches

Outperforming Funds Stop Outperforming

The results of a seminal study on the persistence of fund outperformance have been disputed by a follow-up study using more recent data.

by Matthew Bajkowski | March 2020

 

The results of a seminal study on the persistence of fund outperformance have been disputed by a follow-up study using more recent data.

A well-known 1997 study by Mark Carhart found that between 1963 and 1993, past-year returns for U.S. equity mutual funds positively predict future performance. A follow-up study from the National Bureau of Economic Research (NBER) found this momentum among mutual funds waned over the subsequent period of 1994 to 2018. Even more so, the authors of the study found that within the time period Carhart studied, momentum weakened after 1979.

In reexamining Carhart’s findings, the authors of this more recent study analyzed mutual fund performance through additional factors, including size, value and momentum. They formed equal-weighted portfolios of mutual funds separated into decile groups based on their past one-year performance, with the best-performing 10% of mutual funds in one portfolio, followed by the second-best-performing 10% of mutual funds in another, etc.

Each portfolio was held for one year and was rebalanced for equal weighting each month. The portfolios consisted of actively managed domestic equity mutual funds; sector, hedged and short funds as well as exchange-traded funds (ETFs) were excluded.

In their analysis, the authors’ results supported Carhart’s finding that the top-performing mutual funds between 1963 and 1993 continued to outperform. However, the NBER study also found that the statistically significant difference of the outperformance diminished when they controlled for specific stock traits: size, value and momentum.

Adjusting the returns over the 1994 to 2018 period for the magnitude of outperformance over the risk-free rate led the NBER’s researchers to find that the excess return difference between the top decile portfolio and the bottom decile portfolio was positive but no longer significant. Controlling for three other factors, the difference of the top decile portfolio and the bottom decile portfolio was negative and insignificant.

According to the authors, the deterioration in the one-factor analysis between past winning funds and the past losing funds is a modest decline in the extent to which past winning funds had more specific factors—momentum and value—than past losing funds. Factor portfolios based on momentum and value have performed worse in the last decade or so. (Value has particularly underperformed.)

Source: “Did Mutual Fund Return Persistence Persist?,” by James J. Choi and Kevin Zhao; National Bureau of Economic Research, January 2020.

Discussion

Roger from Florida posted over 6 years ago:

My view: Nothing is forever. I will hold a stock or ETF until performance degrades below their peers. The latest AAII "TOP" MF & ETF tables show no (or VERY little) correlation between, say, year 1 & year -1, -2, -3, -4, -5. Discard it all and just compare charts of top leaders for latest gain & momentum, pick the top ones, buy, and then monitor them similarly. Sell when your holdings deteriorate. Repeat.


Ms. Sneha Joshi from VA posted over 6 years ago:

Hi No panic, please remember the things come up and go down but it's prudent to stick to a well diversified fundamentally strong portfolio (basket) of quality ETFs. May I suggest certain 30 ETFs which fits the bill. They are as under [Ticker Symbols] ARKW,BFIT,DIA,ERUS,FIW,GLD,IHI,IOO,ITEQ,IWP, IWY,LGLV,MFMS,MGK,OLD,PALL,PRNT,PSJ,PTNQ,QQQ, QTUM,SKYY,SLIM,SOXX,UTES,VBK,VT,XAR,XLK,XMMO. This is a broad list.One should also take the help of 'Technical Analysis' {Ref: www.barchart.com}for entry and exit with a Long Term view. Also see www.portfoliovisualizer.com for "Optimization". Best Luck!! Prakash Joshi Retired Sr.Banker > Mumbai,INDIA For & On Behalf of my daughter Ms. Sneha Joshi, who is a member of AAII.


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