Two studies from Vanguard underscore how difficult it is to identify actively-managed mutual funds that not only survive and but also consistently outperform their benchmarks.
The first study shows that the majority of funds across all asset classes failed to outperform their prospectus benchmarks over the past 15 years through 2012:
The chart demonstrates that when assessing long-term performance, it is important to take into account liquidated and merged (“dead”) funds. Otherwise, statistics suffer from a “survivorship bias” that benefits funds still in existence. In addition, in most categories a median surviving fund exhibited a negative annualized excess return vs. the benchmark.
Statistics get worse when style benchmarks, assigned to fund categories, are used:
This is because many funds choose an inappropriate prospectus benchmark that does not reflect the fund’s actual investment style. In a majority of categories the survivors’ excess returns were even lower.
Finally, what are the chances that a fund ranked in the top quintile (20%) of U.S. actively-managed funds in terms of five-year returns through 2007 persisted in the same quintile in the next five years? About 15%, which is less than the 20% expected by chance:
As a matter of fact, about a quarter of such funds wound up in the lowest quintile, and about one-sixth disappeared altogether. Of all the funds available, only about 3% persisted in the top quintile in both five-year periods.
The second study shows that of the 1,540 U.S. domestic equity funds in the 15-year period through 2012, only about 18% survived and outperformed their respective style benchmarks:
However, almost all of these successful funds had five or more years of underperformance within the 15 years of analysis:
Moreover, about two-thirds of outperforming funds experienced at least three consecutive years of underperformance. In many cases, investors would have divested such funds and therefore not realize a full 15-year benefit.
All these findings underscore the need for a close monitoring of mutual fund performance. Outperforming funds are rare and do not persist in their winning streaks. Therefore, a dynamic analysis with a true adjustment for risk is required. Alpholio™ analyzes funds with a monthly frequency and provides buy-sell signals derived from the smoothed cumulative RealAlpha™ curves. These signals, among other inputs, can help investors make informed investment decisions. For more information about the Alpholio™ methodology, please visit our FAQ.