That may be surprising to some. Surely highly paid, intelligent, hardworking, ambitious fund managers with vast resources available to them should be able to outsmart other investors? With the advent and popularity of market tracking index funds, however, weaker investors - including professionals, will have exited the game, leaving the now higher quality pool of survivors competing amongst themselves for winning trades. The bar has been raised significantly. Surely there must be a few great managers out there? Maybe, but identifying them is extremely challenging, contrary to popular belief.
Many studies show that short-term performance rarely persists - funds that perform best in one period rarely carry on this ‘good’ performance, at least with no greater frequency than we would expect simply from by luck.
The chart below shows two consecutive three-year periods. The funds are ranked into quartiles in the first period and then ranked again in the second period. If managers were truly skilled, the top quartile (best) managers should remain top quartile, and the bottom quartile (worst) managers should stay at the bottom. See how the quartiles migrate and notice how many funds fail to survive the whole period or changed style.
Figure 1: The first shall be last (and vice versa)
Diagram: Albion Strategic Consulting. Data source: S&P SPIVA Persistence Scorecard: Does Past Performance Matter? Year-End 2019. Copyright © All rights reserved.
These results are little different to those expected if only luck was at play. Most attempts at fund picking by individuals, or advisers they pay to do this on their behalf use three- to five-year performance data, which means it is almost statistically impossible to tell skilled managers from the noise of the markets. Luck will largely drive outcomes, good or bad.
Even if a fund manager beats the market over a longer timeframe, it does not automatically mean that they are skilled. To separate skill from luck, we need at least 16 years of data to be 95% sure that we are looking at the former rather than the latter. Not very many fund management firms can provide a historical track record that is representative of the team and process currently in place.
That raises several pertinent questions investors should ask themselves. Is it possible to extrapolate past success into the future? On what basis would one take this risk? Will the current manager be around in the future? Without a crystal ball, the odds of picking a skilled, market-beating fund manager for the years ahead is pretty low. There may be some out there, but identifying them today is a real challenge, with a potentially costly downside.
Fund selection based on luck is not a good investment strategy. Investors do not need to play this game. Play the odds in your favour and pick up the market returns you deserve.
Past performance is not necessarily a guide to future performance, and you may get back less than invested.
This article should be used for information purposes only and is subject to change without notice. None of the information contained in this article constitutes financial or other professional advice in any way. If you require additional information, you should contact Magus directly.
While Magus uses reasonable efforts to ensure that the information contained within articles is current and accurate at the date of publication, no warranties are made, either expressed or implied, as to reliability, accuracy or completeness of the information. Magus accepts no liability for any loss arising directly or indirectly from the use of or action taken in reliance on such information.
No warranty is given as to the freedom of this article from errors, defects, viruses, malicious programs or macros. Links from this article exist for information only and Magus accepts no responsibility or liability for the information contained on any such site. The existence of a link to another website does not imply or express endorsement of its provider, product or services by Magus. Please note that clicking on links to external websites will cause you to leave the Magus website.
Magus Private Wealth Ltd is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales No. 3611274. Registered address: Kingfisher House, Northwood Park, Gatwick Road, Crawley RH10 9XN.