Does Past Performance Matter? The View from S&P Dow Jones Indices

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S&P Dow Jones Indices recently released the latest version of its Persistence Scorecard. Any investor who chooses a fund manager based on performance relative to peers should thoroughly study this report. As with all the previous versions of the report, it showed a lower persistence of high performance relative to peers than we would expect from chance alone. To understand what this means, consider the 715 funds that were in the top quartile for the year ending 3/31/2010. Of those 715 funds, only two remained in the top quartile for the next four consecutive years. From chance alone, we would have expected three. The bar chart below tells the story:


These results strongly suggest that luck plays a much larger role than skill in manager performance. This idea is further reinforced when we examine what happened with the 428 funds that were in the top quartile for the five years ending 3/31/2009.

In other words, five years ago, if you started in a top quartile fund (based on the prior five years), you had less than a 9% chance of staying the top quartile without your fund changing its investment style. Furthermore, you had over a 60% chance that your fund would have dropped down to the bottom quartile, drifted away from its initial investment style, or closed/merged into another fund.

So how should investors interpret these findings? Keith Loggie, senior director of global research and design at S&P Dow Jones Indices gave a straightforward answer1 in the New York Times:

“It is very difficult for active fund managers to consistently outperform their peers and remain in the top quartile of performance over long periods of time. There is no evidence that a fund that outperforms in one period, or even over several consecutive periods, has any greater likelihood than other funds of outperforming in the future.”

Of course some investors (or active managers) may interpret the report in the opposite way—as proof that there are at least a few funds that routinely trounce the market. In this case, there were two of them. The enterprising author of the New York Times article actually contacted S&P Dow Jones Indices and found out the names of those two funds—The AMG SouthernSun Small Cap Fund and the Hodges Small Cap Fund. The former is closed to new investors.

Naturally, we dug a little deeper into those two funds. First, we ran their calendar year returns agains their Morningstar analyst-assigned benchmarks. The charts below show that neither fund showed significant alpha (a t-statistic of 2 or greater, indicating a 95% or greater chance of skill as the explanation for the returns).


Next, we ran a three-factor regression to see how much alpha there was after adjusting for exposure to market, size, and value risk factors. The Hodges Small Cap Fund produced an alpha of 3.8% with a t-statistic of 0.9, and the AMG SouthernSun Small Cap Fund produced an alpha of 3.0% with a t-statistic of 1.2. Neither one of these funds showed significant alpha. One flaw in the three-factor regression analysis is that it only accounts for the average risk exposure over the whole period as oppose to the differing risk exposures at each point in time. As seen in the charts below, both funds showed a substantial amount of style drift, particularly between growth and value. This indicates that the benchmarks selected by Morningstar have not accurately captured the risk exposures taken by these funds over the years.

Michael W. Cook, the lead manager of the AMG SouthernSun Small Cap Fund offered some sound advice for investors:

“Index funds deserve to be core holdings for many investors…One thing you don’t want to do is just read about performance numbers — ours or anybody else’s — and put money into an investment. Chasing past returns doesn’t make sense.”

We at Index Fund Advisors will continue to do our part to discourage investors from chasing past returns or engaging in other destructive behaviors such as relying on managers rather than markets to deliver returns.


1Somer, Jeff, ”Who Routinely Trounces the Stock Market? Try 2 Out of 2,862 Funds”, New York Times, 7/19/2014.