S&P: Top mutual funds highly unlikely to maintain success

New study suggests performance is almost impossible to maintain, but managers said the study has little utility to investors

Jul 11, 2014 @ 12:36 pm

By Trevor Hunnicutt

Mutual funds, fund performance, active management vs. passive management
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Do you own a poorly performing mutual fund? Next year, it might be at the top of the category. The opposite could be true for those top-performing funds.

A new study by S&P Dow Jones Indices found that a minuscule number of funds retain their top rankings over two-, three- and five-year periods.

But fund managers say the results, while offering facile fodder to proponents of index-based investing, ignores the importance of long-term track records and offers little substance for investors interested in the factors that separate good managers from bad.

The study found that few funds with above-average performance failed to maintain that distinction for each of the three- and five-year periods ended March 31. Only 3% to 5% of funds — depending on the size of the companies they were exposed to — maintained top-half performance for five consecutive years. Between 14% and 25% were able to do so over three consecutive years.

For funds in the top quartile in March 2012, only 3.78% maintained that position in March 2014, the study said.

“Very few funds can consistently stay at the top,” according to the report, authored by the index provider's director of global research and design, Aye M. Soe. “The figures paint a poor picture of the lack of long-term persistence in mutual fund returns.”

Investors regularly turn to past performance when deciding which mutual funds to buy. Research firms Phoenix Marketing International and Cerulli Associates Inc. found in 2012 that 47% of investors use past performance as a top factor in considering funds — more than any other factor.

Some investors have and always will prefer to choose fund managers that they hope to outperform consistently, according to some proponents of building portfolios with allocations to index-based products like index funds and exchange-traded funds.

“There will always be people who refuse to be average,” said Dave Nadig, chief investment officer for ETF.com, a research firm. “The overwhelming momentum is on the side of rational, academic finance-based investing.”

S&P Dow Jones Indices, which conducted the study, builds the benchmarks that are used to track market performance and licensed by fund companies to underpin index-based products.

“If you have always put yourself into the camp of passive — if you're an ideologue on the fact that active management can't work or doesn't work, this is great reading,” said Tony Scherrer, director of research and a portfolio manager for Smead Capital Management.

He said managers are looking to build wealth over time — and that it's impossible to generate alpha consistently each year — but investors should be looking at longer-term performance along with factors like the quality of the portfolio, the concentration of the holdings, the turnover, trading costs and degree to which the manager deviates from benchmarks.

“If you're a long-time horizon manager, of which there aren't many these days, you're looking to create wealth,” he said. “I don't know what the value is in understanding the consistency of a manager to stay in the very top of the game in every 12-month rolling period. I don't know if that has any merit.”

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