There is a fair amount of “buzz” around why successful actively managed mutual funds can not be successfully chosen ex-ante (beforehand) given that there is little evidence of persistence of mutual funds that outperform their peer group from one period to the next. In otherwords only a fraction of mutual funds that originally outperformed in the first measured period outperformed in the second measured period.
Vanguard’s research on persistence (PDF: The Case for Indexing) published 04/14 highlights its version of the persistence challenge. Researchers at Vanguard looked at 5,945 mutual funds with 5 year track records at the end of 2008. It reported that only 145 funds of the original 5,945 remained in the top 20% of top performing funds. That’s 2.4% of the original funds! While that sounds like some disappointing results — maybe its not so bad.
But first, it seems strange to me that any valid information can come out of a study when 32.1% of the original funds were merged or liquidated/closed at the end of 2013. Again 1,910 of the 5,945 funds did not complete the second 5 year measurement period. That seems to be an issue that should be addressed before any conclusions can really be made.
Regardless, the key takeaway from these types of studies on persistence should be that no style of investing works in all market conditions. Sometimes growth companies outperform value companies and large companies outperform small companies. The value premium has been shown to be variable not unlike the equity premium. Therefore persistence shouldn’t be expected through a market cycle. That’s the education that investors should be given. In passing Vanguard acknowledged this in a brief comment in their study:
Another key factor is that of consistency—that is, keeping
a good manager, once one is found, rather than rapidly
turning over the portfolio. Maintaining the ability to filter
out noise—especially short-term measures of performance
versus either benchmarks or peers—is furthermore crucial.
At the end of the day — there is plenty of evidence of active management falling short of generating excess returns over its appropriate benchmark but it seems that there are too many structural flaws in the mutual fund industry to take these types of studies seriously. A mutual fund not being persistent in outperformance over a rolling 1, 3, or 5 year period still might seem shortsighted as Vanguard duly notes.