Can the past outperformance by an actively-managed investment fund provide a guide to the likeliness of its outperformance in the future?
Researchers looking at this question over the past 50 years or so have widely concluded that persistent outperformance by a fund manager is rare.
In the prevailing low-interest investment environment with expectations for lower returns over the medium-to-long term for diversified portfolios, some investors may be more tempted to try to pick winners. And many investors taking this approach would tend to invest in past winners in the hope that a manager’s past outperformance will be repeated.
Yet as the body of research suggests, today’s winners have a strong chance of becoming tomorrow’s losers in terms of performance. Meanwhile, today’s losers could become tomorrow’s winners.
Vanguard research published this month confirms once again that an actively-managed fund’s past performance is not an accurate guide to its future performance. And chasing performance by switching between funds as their performance rises and falls is likely to be a wasted and costly exercise.
In this new research, analysts first ranked all actively-managed US share funds in terms of their performance the in the ï¬ve years to December 2011. Then the performance of the funds was tracked over the next following ï¬ve years to December 2016.
"If managers were able to provide consistently high performance, we would expect to see the majority of first-quintile funds remaining in the first quintile," the analysts write. However, the majority of managers "failed to consistently outperform".
Of the 1108 share funds in the top performance quintile (top 20 per cent) for the first five years to December 2011, only 15.6 per cent remained in the top quintile for the second five-year period. Further, 21.3 per cent had fallen to bottom quintile (lowest 20 per cent) while 25.3 per cent had merged or been liquidated.
And of the 1114 share funds in the bottom quintile for the first five years to December 2011, 15 per cent had risen to the top quintile for the second five-year period. Only 9.2 per cent remained in the lowest quintile however 47.7 per cent were merged or liquidated.
This research underlines that consistent outperformance by fund managers is rare and that investors can pay a high price in forfeited returns by chasing performance.
Finally, other Vanguard research shows that investors over the medium-to- long term often underperform the managed funds currently holding their capital because of their adoption of a hire-and-fire, performance-chasing strategy.
Taking such approach can mean investors consolidate losses when a once top-performer falters yet miss out on gains when a one-time poor performer begins to outperform.
Significantly, many investors who recognise that consistent outperformance by a fund manager is rare believe, like Vanguard, that there is a place for favoured actively-managed funds in their diversified portfolios.
Such investors often adopt a core-satellite approach, investing the diversified core of their portfolios in low-cost index funds, including index-tracking Exchange Traded Funds (ETFs), while holding smaller satellites of favoured actively-managed funds and direct investments.
Factors that should improve the probability of success with actively-managed funds are low investment management costs and a recognition by patient investors that their carefully-chosen managers will experience almost inevitable bouts of underperformance, even for extended periods.
