Once Famous?
Quarter end is upon us again, which means that fund lists will be published touting the latest investment category winners.
These lists will create headlines, may inspire special sections in journals, and generate clicks, which will make the funds who buy the accompanying banner ads happy.
Do they add value to investor portfolios, however, and generally result in sad outcomes for those who are attracted to the lists of recent winners?
One of the most consistent places to look for an answer comes along each year from S&P Global in the form of their Persistence Scorecards. They keep tabs on whether or not top managers persist in staying at the top.
What does the data consistently say?
Having a little fun with an old saying, the higher a manager flies on a list, the more they seem to fall.
The eye-popping result this time…
“Of the top-half funds of 2016, 21.4% repeated that accomplishment in 2017, with just 4.8% ranking in the top half each year through 2020.”
These might seem to be astonishing results, but unfortunately not.
We pulled this quote from a previous S&P Persistence Scorecard, for a piece we published in 2017:
“No large-cap, mid-cap, or small-cap funds managed to remain in the top quartile at the end of the five-year measurement period.”
This incredible lack of performance persistence – by the insanely smart, well-credentialed, and hard-working people managing these funds – does not exactly support the “outperformance is a result of skill” argument.
If anything, it suggests that more success is attributable to luck than we give it credit for.
I can imagine putting together some fascinating conference panels to chew this over. I might ask, given these results:
- What is the purpose of investment research and does it add value?
- Is professional talent in fund management allocated appropriately between investing and raising funds?
- If allocations to active managers are essentially low probability bets, are they deployed appropriately?
The last one is particularly interesting for fiduciaries.
If winning in investing is making fewer mistakes, then it’s all about probabilities. The data suggests that active management is, essentially, a low probability bet with a big ante. It can be fun and exciting, often featuring interesting and compelling, alpha personalities, but it has a cost, and data suggests the chance of experiencing multiple years of outperformance or investment alpha is random at best.
For fiduciaries, what is an appropriate allocation to a strategy with this profile?
We consistently ask these questions ourselves and wrote this when asked to comment on it for a trustee publication, Trust & Estates.
“Paraphrasing the wisdom of Berkshire Hathaway’s Warren Buffett and Charlie Munger and the origins of the word prudent, I would argue this – A fiduciary should stay focused on a judicious and rational review of the evidence to avoid big mistakes and wisely remember that excitement can be an enemy of what’s most suitable and profitable.”
I think the key word there is “evidence” and, according to S&P’s most recent Persistence Scorecard review, this is what it shows:
“98.5% chance that a top-quartile fund will not stay in the top quartile for the next four years.”
The whole story brings to mind a Howard Marks line…
“Our industry is full of people famous for being right once in a row.”
Back to where we started, quarter end top fund publications can make some investment managers famous. Before following these lists and buying these funds, just beware.
Famous funds may only end up being famous once.
Related Reading:
It’s All Greek to Me