The majority of top stock pickers can’t maintain their superior performance over a couple of years, according to a new report.denphumi/Getty Images/iStockphoto
Even the best stock pickers may be benefiting more from luck than skill.
The vast majority of top-performing fund managers are unable to maintain superior returns over even a couple of years, according to a new report by S&P Dow Jones Indices, adding to the existing weight of evidence disputing the effectiveness of active management.
"Demonstrating the ability to outperform peers repeatedly is the only proven way to differentiate a manager's luck from skill," Aye Soe, S&P Dow Jones Indices' senior director of global research and design, said in the report.
But, she added, "relatively few funds can consistently stay at the top."
Consider the 1,328 domestic U.S. active funds that ranked in the top half for the year ending March, 2012. Only 80 of them, or 6 per cent, managed to stay in the top half of funds for the next four consecutive years, according to S&P's latest version of its Persistence Scorecard. Chance alone would have suggested 83 of them to repeat their outperformance over that time.
As with previous instalments of the report, active funds had a lower rate of consistent outperformance relative to peers than random expectations would suggest. Even lowering the time frame to three years raises the repeat rate of top-quartile performance to just 7.3 per cent.
It's already been a lousy year for active management in the U.S. as well as Canada.
Just 17 per cent of large-capitalization equity-fund managers in Canada outperformed the benchmark in the second quarter, which is the lowest beat rate among available data, going back to 1999, according to Russell Investments.
And the first half of the year was the worst on record for U.S. stock pickers, according to Merrill Lynch data going back to 2003. Last month, the firm reported that just 18 per cent of U.S. active managers beat a basic index in the first half of 2016.
Those dismal figures coincide with a rise in popularity of a lower-cost, passive style of investing through exposure to basic indexes.
The S&P report has repeatedly shown that even those funds that manage to beat most of their peers have no greater likelihood of doing so in the future.
When considering the top 25 per cent of funds, the repeat rate falls to near zero. Of the 664 U.S. active domestic funds in the top quartile in 2012, a grand total of three of them remained in that upper echelon over the following four years.
Additionally, investors who started in one of those top funds five years ago would have faced a 40-per-cent chance that their fund would either fall to the bottom quartile, or be liquidated or merged.
Most investors would be familiar with some version of the disclaimer typically found in mutual fund fine print: "Past performance is no guarantee of future results."
"Yet, due to either force of habit or conviction, investors and advisers consider past performance and related metrics to be important factors in fund selection," Ms. Soe said in the report.
Tim Shufelt