Some investors select mutual funds based on their past returns. Yet, past performance offers little insight into a fund’s future returns. For example, most funds in the top quartile (25%) of previous three-year returns did not maintain a top‐quartile ranking in the following three years.
Some investors may resort to using track records as a guide to selecting funds, reasoning that a manager’s past success is likely to continue in the future. Does this assumption pay off? The research offers strong evidence to the contrary.
This exhibit shows that among equity funds ranked in the top quartile (25%) based on previous three-year returns, a minority also ranked in the top quartile of returns in the following three-year period.
A lack of persistence casts further doubt on the ability of managers to consistently gain an informational advantage on the market. Some fund managers might be better than others, but track records alone may not provide enough insight to identify management skill. Stock and bond returns contain a lot of noise, and impressive track records may result from good luck. The assumption that strong past performance will continue often proves faulty, leaving many investors disappointed.