Each and every year, generally in the first quarter of the year, top performing funds receive accolades from various media outlets. It’s hard to miss these rave reviews of top performing funds, as they are mentioned in nearly every major finance magazine and website.
Whether it’s Morningstar’s “Fund Managers of the Year” or Barron’s “Top Fund Families,” the point is always the same. The point is to recognize the top performing funds. But should you purchase these top performing funds?
Top Performing Funds and the Cover Story Curse
BusinessWeek’s "cover story curse" comes to mind when considering top performing funds that are recognized in the media. The so-called “cover story curse” is associated with companies that are highlighted on the cover of BusinessWeek.
A host of analysts studied the curse at several business magazines -- BusinessWeek, Forbes and Fortune -- and they concluded, “a positive or negative cover story marks the end of a company’s extreme behavior, either good or bad. After the cover story, they tend to regress, in their corporate way, toward the mean.” Surprisingly, BusinessWeek sponsored the study. Is there a curse on top performing funds that win awards and grace the covers of business and finance magazines?
While there may not be a “cover story curse” study involving top performing funds, a review of past winners’ most recent performance might shed light on this subject.
Persistence of Top Performing Funds
Standard & Poor's Mutual Fund Performance Persistence Scorecard provides semi-annual results on the persistence of top performing funds. The reports show performance of actively managed mutual funds and monitor the consistency (or persistence) of their performance results.
The Standard & Poor’s studies have shown that screening for the top funds based only on performance is inappropriate. Srikant Dash, Index Strategist at Standard & Poor’s, says, “Very few funds repeat a top-quartile performance. Furthermore, Standard & Poor’s research shows that a healthy percentage, and in most cases a majority, of top-quartile funds in the future will most likely come from the ranks of prior period second and third quartiles.”
Additional Research on Top Performing Funds
In addition to the Standard & Poor’s research on the persistence of top performing funds, other firms that have researched the topic.
Barclays Global Investors -- The evidence from a Barclays Global Investors study shows that the chance is slim for continued outperformance by an active manager to continue beating the index.
For the period of December 31, 1992 to December 31, 2007, only 41.6% of actively managed U.S. large company funds that beat the S&P 500 in a particular year were able to beat the S&P 500 in the next year. After three years, only 9.7% of the original group was still beating the index. The numbers are similar for actively-managed small cap funds and emerging market funds.
Greycourt -- Greycourt says, "The main mistake investors make in engaging managers is hiring a firm that has experienced good recent performance -- say, a better-than-average five-year track record. The reason this is a mistake is that, more often than not, a good five-year track record says virtually nothing about how the manager is likely to perform over the next five years."
RW Baird -- RW Baird says, "It’s only natural for investors to look at past performance when selecting managers of either mutual funds or separate accounts. Almost everyone is impressed by a strong track record. However, investors may be making a crucial mistake by fleeing from recent losers and flocking to recent winners, especially if they act on relatively short-term results.”
