The phrase “past performance is not an indicator of future success” can be found in the fine print all fund literature. Yet, due to either force of habit or conviction, investors and advisors consider past performance and related metrics to be important factors in fund selection. Behaviourally, we gravitate towards the dream manager – the best manager.
So does past performance really matter? According to the S&P Persistence Scorecard, relatively few funds can consistently stay at the top. Out of 563 US equity funds that were in the top quartile as of September 2015, only 6.39% managed to stay in the top quartile at the end of September 2017. Furthermore, 6.48% of the large-cap funds, 1.23% of the mid-cap funds, and 6.82% of the small-cap funds remained in the top quartile.
Research from S&P Dow Jones Indices gives a clear message, there is almost no such thing as a consistently performing manager. Being good is mostly luck.
When it comes to the active versus passive debate, one of the key measurements of successful active management lies in the ability of a manager or a strategy to deliver above-average returns consistently over multiple periods. Demonstrating the ability to outperform peers repeatedly is the one way to differentiate a manager’s luck from skill.
For the three-year period that ended in September 2017, persistence figures for funds in the top half were closer to the random expectation than that of the top quartile. Over three consecutive 12-month periods, 19.49% of large-cap funds, 18.52% of mid-cap funds, and 23.11% of small-cap funds maintained a top half ranking.
An inverse relationship generally exists between the measurement time horizon and the ability of top-performing funds to maintain their status. It is worth noting that no large-cap, mid-cap, or small-cap funds managed to remain in the top quartile at the end of the five year measurement period. Furthermore, no mid-cap or small-cap funds were able to retain their status as of the end of the fourth period. This figure paints a negative picture regarding long-term persistence in mutual fund returns.
Similarly, only 4.73% of large-cap funds, 6.47% of mid-cap funds, and 5.49% of small-cap funds maintained top-half performance over five consecutive 12-month periods. Random expectations would suggest a repeat rate of 6.25%.