Mutual fund companies love to tout the past performance of their best funds in their marketing materials.
But those very companies are also the first to tell you that past performance is no indicator of future success.
S&P’s Aye Soe examined the three and five year performances of hundreds of equity mutual funds to see how many top funds were able to stay in the top 25th and 50th percentiles.
“Out of the 682 domestic equity funds that were in the top quartile as of March 2013, come the end of March 2015, only 5.28% had managed to stay in that top quartile,” Soe found. “Further, 3.95% of the large-cap funds, 5.26% of the mid-cap funds, and 4.67% of the small-cap funds remained in the top quartile.”
The numbers fall much more dramatically when you extend the measurement period out to five years.
“An inverse relationship generally exists between the measurement time horizon and the ability of top-performing funds to maintain their status,” Soe added. “It is worth noting that no large-cap, mid-cap, or small-cap funds remained in the top quartile at the end of the five-year measurement period. This figure paints a negative picture regarding the lack of long-term persistence in mutual fund returns.”
The failure of funds to stay on top over a five-year period is summarized in the table below.
Interestingly, Soe found that being contrarian was a more successful strategy than banking on the leaders.
“The data show a stronger likelihood for the best-performing funds to become the worst- performing funds than vice versa,” Soe said. “Out of the 427 funds that were in the bottom quartile, 15.93% moved to the top quartile over the five-year horizon, while out of the 427 funds that were in the top quartile, 21.78% moved into the bottom quartile during the same period.”
So, what does all this mean?
Without examining the makeup of these funds more closely and the process of the managers more carefully, there’s not much to conclude except that good past performance doesn’t guarantee good future performance.
“Demonstrating the ability to outperform repeatedly is the only proven way to differentiate a manager’s luck from skill,” Soe said.