Consistency of fund performance – which by implication, of course, means consistency of outperformance – is a much-prized quality in the world of investment.
That is wholly understandable – after all, everyone who invests in a fund will naturally hope that fund will outperform the market or peer group against which it benchmarks itself.
Is it, however, a realistic aspiration?
A recent report from financial data giant Morningstar suggests not, arguing the most successful actively managed funds over the longer term have not been what it calls ‘persistent’ – but, then again, neither have passively run ones.
Consistent performance is often “put on a pedestal”, notes the paper Quit Chasing Unicorns: Consistent Fund Performance is Overrated, before concluding: “It does not belong there.”
Do the top 25% consitently stay in the top 25%?
The report focuses on funds that were in the top 25% or ‘ top-quartile’ of performers over the decade to 30 November 2018 and then checks how many of these managed to achieve top-quartile performance for three years in a row at some point in that 10-year period.
Of the 1,188 long-term outperformers, the report found, 702 never managed to do so even once while just 73 did so four or more times.
Passive funds are “even less likely” to pull off this trick, the report adds, with just 16 of 58 top-quartile index-trackers doing so even once over the same period.
“It’s not like these funds were strangers to success during the 10 one-year periods to 30 November 2018,” it concludes. “In fact, the average outperformer had nearly five top-quartile years over this span. It’s just they didn’t usually put up three stand-out showings in a row.”
Do consistent performers outperform in the end?
The report also considers the question of whether more consistent performers – be that consistently good, bad or mediocre – are likelier to outperform in the end.
To do this, it ranked funds by the degree to which their annual peer-group positions varied over the 10-year period – from the “least volatile” 25% to the most volatile” 25% – and then tracked the 10-year performance of funds within those quartiles.
Morningstar concludes that funds in the least volatile quartile – that is, those whose rankings see-sawed least over the decade – were “a bit likelier” to outperform their average peer than other funds. “But the steadiest funds landed in the top quartile after 10 years about as often as funds whose ranking swung around more,” the report adds.
Given the apparent improbability of identifying any fund – active or passive – that will outperform its peers year after year after year, it is tempting to conclude investors would do better to pick an investment strategy with which they feel comfortable and then stick with it for the longer term.
And that conclusion is only strengthened by a growing body of research on the gap between fund and investor returns.
Pick and stick
It is an unfortunate fact of investment life that while funds can have a hard time outperforming their own benchmark, on average they have no trouble outperforming their own investors.
This is because, as we discussed in Actively dangerous, investors tend to sell active funds after these funds have done poorly and buy them after they have made gains.
As it happens, bad timing is another aspect of investing to have attracted Morningstar’s attention and indeed the group has been publishing an annual Mind the Gap study since 2005.
This tracks the difference between funds’ ‘time-weighted’ and ‘dollar-weighted’ returns – in effect, comparing what the average fund has returned versus what the average investor actually saw.
The latest study found the average dollar invested in open-ended funds gained 5.5% a year over the 10 years to 31 March 2018, while the average fund returned 5.8%.
While this is actually the narrowest gap recorded since 2005, 30-odd basis points per year is still quite a drag on performance – especially when, as we noted in Investment equation, investors these days are going to great pains to force down the cost of their investments.