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Measuring Persistence in Fund Performance

Last week, I explored Standard and Poor’s most recent index versus active scorecard. In short, that report showed that the majority of mutual fund managers underperformed their respective benchmarks.

Little did I know that Standard & Poor’s also publishes a semi-annual report tracking persistence in outperformance for the fraction of fund managers who outperformed their benchmark in a given year. This report also tracks style consistency and survivorship, which, respectively, give an indication of what proportion of managers migrated from one area of the market to another and how many funds were merged or liquidated in the period studied.

Here are some of the key conclusions from the most recent report I could find:

  • For the five years ending March 2012, less than 6 percent of large-cap, mid-cap and small-cap managers who were in the top half of performers in the first year managed to stay in the top half in each of the next four years. If manager outperformance were random, you would expect 6.25 percent to achieve this result. Conclusion: basically no evidence of investment management skill.
  • Using a longer window of time, only 6 percent of large-cap managers with top quartile performance over the five years ending March 2007 maintained top-quartile performance over the next five years. The numbers were 4 percent in mid-cap and 16 percent in small-cap. Randomly, you would expect to see that 25 percent of managers maintained top quartile performance in the second five-year period. Again, very little evidence of true investment management skill.

One of the more staggering statistics in the report is that roughly 25 percent of all funds studied over the five years ending March 2007 were either merged or liquidated over the five years ending March 2012. I don’t know what I would’ve guessed this percentage would be, but I wouldn’t have guessed this high. On the style consistency front, roughly 14 percent of the funds studied over the five years ending March 2007 changed their style over the next five years.

Random Links and Commentary of the Week

Here’s a new piece from Vanguard that seems to confirm what I’ve long suspected. While larger endowments (the Yales and Harvards of the world) seem to have performed well relative to more passive strategies, the medium- and smaller-sized endowments generally haven’t. While I can certainly believe that some of the larger endowments possess true investment skill, I’ve never believed that skill translated well to the majority of endowments. Further, as Vanguard points out the bigger endowments have economies of scale that can’t be replicated either.

Jared Kizer is the director of investment strategy for BAM Advisor Services. See our disclosures page for more information.
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