The factor most often leveraged by those who market their investment management services—be it a hedge fund, mutual fund, separate account manager, or your corner stock broker—is past performance. Which is interesting, since the CYA that follows every performance ad says past performance is not indicative of future results. Of course, despite the disclaimer—which is there per regulatory requirement—past performance does indeed say a lot about the skills of a given manager, right? Well, it depends.
For starters; if we’re considering sector funds, past performance, generally, will be more a factor of the performance of the sector (tech, financials, energy, etc.) than of manager-skill. That’s why, anymore, we’re resorting to low cost sector index exchange traded funds in client portfolios. In which case, whether or not a given sector has outperformed a broad market index over the past 3 years—considering cyclicality—is of zero importance. In fact, while rebalancing—considering cyclicality—we often rotate client portfolios to sectors that have been relative under-performers of late.
As for actively managed funds, sure, past performance takes on more significance. Since all things market are cyclical, you should always buy the fund with the worst recent track record—odds are you’ll be catching it right when the cycle turns to favor its manager’s strategy. Ridiculous? Well, yeah, but no more so than buying a fund solely because it sports the best recent track record.
Let’s do our own little experiment: I’ll go to Morningstar’s database right now and pull up all U.S.-based mutual funds, and, starting at the top, I’ll record the calendar year performance ranking among peers for the first 5 funds that show track records back to 2008. And we’ll see how we’d have done chasing yearly track records. Be right back…
Okay, I’m back. The first thing I realized when I went to Morningstar was that looking at just the first 5 funds would have forced me to pick solely on the Aberdeen fund family. So I grabbed the first Aberdeen fund with a track record going back to 2008, then jumped to the next fund family and took its first with a 2008-forward record, and so on. Here are the results:
Aberdeen Asia Bond Institutional:
2008: Underperformed 89% of its peer group. (REALLY BAD)
2009: Outperformed 91% of its peer group. (GREAT)
2010: Outperformed 92% of its peer group. (GREAT)
2011: Underperformed 79% of its peer group. (BAD)
2012: Outperformed 83% of its peer group. (GREAT)
Acadian Emerging Markets Institutional:
2008: Underperformed 84% of its peer group. (BAD)
2009: Outperformed 71% of its peer group. (VERY GOOD)
2010: Outperformed 80% of its peer group. (GREAT)
2011: Underperformed 52% of its peer group. (MEDIOCRE)
2012: Outperformed 88% of its peer group. (GREAT)
Access Capital Community Investment I
2008: Underperformed 70% of its peer group. (BAD)
2009: Outperformed 84% of its peer group. (GREAT)
2010: Underperformed 75% of its peer group. (BAD)
2011: Underperformed 84% of its peer group. (BAD)
2012: Outperformed 78% of its peer group. (GREAT)
Adams Harkness Small Cap Growth
2008: Underperformed 73% of its peer group. (BAD)
2009: Underperformed 91% of its peer group. (REALLY BAD)
2010: Outperformed 89% of its peer group. (GREAT)
2011: Underperformed 74% of its peer group. (BAD)
2012: Underperformed 54% of its peer group. (MEDIOCRE)
Adaptive Allocation C
2008: Outperformed 99+% of its peer group. (FANTASTIC!)
2009: Underperformed 95% of its peer group. (REALLY REALLY BAD!)
2010: Outperformed 97% of its peer group. (FANTASTIC!)
2011: Underperformed 96% of its peer group. (REALLY REALLY BAD!)
2012: Underperformed 99+% of its peer group. (REALLY REALLY REALLY BAD!!)
Now of course that’s only five, but it is, honestly, the very first five. Run the first 50 or the first 5,000 and I suspect, by and large, you’ll see the same patterns. Which gives you absolutely zero faith in the notion that track records are the most important consideration when allocating your portfolio.
In the end, it’s future—as opposed to past—performance we’re after. And while, as advisors, we are forever striving to add value at the margin through intelligent sector selection, what makes successful long-term investors successful is that they maintain an asset allocation that matches their time horizon, appetite for risk, income needs, etc. And that they never, ever, ever chase track records…
For more on the subject read No Magic Pill…