Active Investor

Past Performance is No Guarantee of Future Results

Active Investor

Unlike the 30-year risk and return characteristics of an index, the past performance of money managers has no bearing on their future performance. We have yet to see a reputable study of mutual fund performance that reveals a reliable way to know if past superior managers will win again in the future. This is why some variation of the disclaimer “past performance is no guarantee of future results” must appear in all mutual fund advertisements and prospectuses.

Studies show that those who have outperformed some past benchmark are more likely to underperform it in the future. Burton Malkiel, author of the long-time investment best seller, A Random Walk Down Wall Street, conducted a study in 1995. In the study’s conclusion, he states, “It does not appear that one can fashion a dependable strategy of generating excess returns based on a belief that long-run mutual fund returns are persistent.”

Investment experts give several reasons why past performance is no guarantee of future results. The most frequently cited is that any outstanding track record turned in by a money manager is the result of the market favoring his particular investment style. One implication of this is that any such performance is entirely unpredictable—as is the time period that such good fortune may or may not last. Since market returns are correlated to risk factors (not to managers), there is no reason to expect that one manager will do better than another.

In addition, outstanding performance is often achieved when a mutual fund is small. This performance usually fuels an exponential growth in the amount of money that must be invested by the fund. The trading and other costs generated by the investment of this much larger amount of money can neutralize or even outweigh the margin by which a mutual fund manager may beat the market in the future.

Professor Ken French explains why manager picking is such a terrible idea.

One regularly updated study that we often cite is the Persistence Scorecard by S&P Dow Jones Indices. It shows that the level of persistence of high-performing managers is actually lower than what we would expect from chance alone! That is why we say that investors who pick managers based on track records are playing a mug’s game.