Past Performance is no Guarantee of Future Results
Star fund managers’ reputations are built upon periods of good performance and, despite the warnings in the small print, the funds they manage are heavily promoted based on that past performance. But how reliable is past performance as an indicator of future results?
Much of what you read about investing highlights only the successes. Star fund managers’ reputations are built upon periods of good performance and, despite the warnings in the small print, the funds they manage are heavily promoted based on that past performance.
You might therefore be surprised at how few fund managers are able to deliver good performance over more than a few years; and how fewer still are able to repeat that good performance. An annual study by Dimensional Fund Advisors reveals how hard it is for investors to pick a winning manager based on past performance.
A thorough study of past performance OF US mutual funds
Every year, the study analyses returns of US-based mutual funds to determine how many funds outperform an industry benchmark after costs. This year’s study encompasses thousands of mutual funds invested in US equities, international equities, and fixed income.
The study concentrates on the US market because it is the largest and most accessible fund data in the world. It includes funds that invest and are managed all around the world. And, because we have no reason to believe that fund performance is influenced by where it is registered for sale, we think the study is relevant to investors everywhere.
For equity funds, over the past 5 years, not all funds survived, and only 26% of funds survived and outperformed after costs. Beyond 5 years, the percentage of top performing funds that survived and outperformed was even smaller, dropping to 14% after 15 years.
The study also finds similar results for fixed income funds, where 28% of funds survived and outperformed benchmarks over 5 years, and 13% survived and outperformed over 15 years.
Do winners keep on winning?
You might look at these results and say, why not just pick the funds that outperformed? But that approach relies on the persistence of outperformance over time and the study highlights how rare that is.
It turns back the clock three years and imagines investing using past performance as a guide. To pick a fund, it looks at returns over the previous three- year period and considers only funds that were in the top 25% (the top quartile) of returns. It then takes those top performers and observes how they performed over the next three years.
The study performed this exercise for the past 12 years and found that, on average, only 26% of top quartile equity funds over three years repeated their top-quartile performance for the next three years. Only 32% of fixed income funds repeated their top-quartile performance.
Exhibit 1. Percentage of Top-Ranked US Mutual Funds That Stayed on Top
Past performance is no guarantee of future results. Indices are not available for direct investment.
Index performance does not reflect the expenses associated with the management of an actual portfolio.
You could read this result to mean that a few skilful managers are able to perform well over more than a handful of years. That might be the case, but the number of funds that did repeat their top quartile performance was about the same as you would expect by chance alone.
The implication of the study’s findings is that while past performance records may provide some information about whether a fund manager is delivering what they set out to achieve, investors should not rely solely on it to choose their investment funds. We agree with this conclusion which is why we have developed a sensible investment philosophy to guide our investment decisions and, using a systematic approach, aim to outperform the market without outguessing it.
 In the study results, “benchmark” refers to the Morningstar category index used to evaluate the performance of each respective mutual fund in the sample. See “Important Disclosures” for additional information.
 Survivors are funds that had returns for every month in the sample period. Outperformers are funds that outperformed their respective Morningstar category index over the period.