CLICK HERE to view "The Results of Conventional Investing"

Mutual fund research shows that conventional investing has low odds of success.

Over the 15-year period ending in 2017, only 14% of stock managers and 13% of bond managers survived and outperformed their benchmarks. Said another way, 86% of stock managers and 87% of the bond managers who started the 15-year period underperformed their market index. About half of the stock and bond managers did not even survive the 15-year period.

Some investors try to improve these odds by picking managers who have outperformed in the past. There’s a significant amount of research into the persistence of manager performance. It shows that among managers that outperformed in the past, only a small fraction continued to beat their market benchmark in the future.

Should we be surprised by this poor record of performance? Not really. This makes sense if market prices are the best estimates of actual value.

Manager underperformance is not necessarily due to a lack of knowledge or expertise. In fact, many professional investment managers are very bright, educated, and hard working. The problem is that this high level of expertise and motivation results in intense market competition, which drives prices to fair value.

With the advent of computing power and data availability, academic research has documented the poor outcome of most conventional managers. This is one reason for the rise in the popularity of another investment approach—indexing.

The Search for Persistence

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 evidence to the contrary.

The exhibit shows that among funds ranked in the top quartile (25%) based on previous three-year returns, a minority also ranked in the top quartile of returns over the following three-year period. This lack of persistence casts further doubt on the ability of managers to consistently gain an informational advantage on the market.

For example, in 2017, only 29% of equity funds were ranked in the top quartile of performance in their category in both the previous period (2012–2014) and subsequent period (2015–2017). Over the 12 years through 2017, top-quartile persistence of three-year performers averaged 26% for equity funds.

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, potentially leaving many investors disappointed.

CLICK HERE to view "The Results of Conventional Investing"