Can You Select Long-Term Fund Winners?
Yes, yes you can. But it will probably be an accident. And selecting them won’t even be the hard part…
In a fascinating post at Research Affiliates about the perils of real-time performance measurement, John West and Amie Ko look at the longest-term winners in a mutual fund data series that goes back to the 1970’s…
As Burton Malkiel noted, we can count on the fingers of one hand the number of equity mutual funds that have beaten the market by at least 2 percentage points over more than a 40-year period. In 1970 there were over 350 U.S. equity mutual funds available to investors; of those, 30% have survived the entire 45-year period. The rest—nearly 250 funds—were merged or liquidated, presumably due to poor track records.
What are the chances of selecting a fund that has survived the full period and outperformed the S&P 500 Index? Of the initial 358 funds, 45 have both survived and outperformed. Of these long-term outperformers, only three achieved an excess return of 2 percentage points or more. This suggests that the odds of identifying a long-term superstar who outperformed by 2 or more percentage points is a mere 0.8%, a 1-out-of-119 chance. With these odds, you actually have a slightly better chance of collecting a cash prize on the multi-state Powerball lottery (not the Mega Millions Grand Prize, but still a payout!).
Those are fairly daunting odds, are they not?
Later on, West and Ko look at these stellar performers over the years and reach some shocking conlcusions about how much time the winners spent looking like losers. All of the best funds had gone through substantial periods (five years) during which they underperformed their peers dramatically. So even if you had selected the best funds from the start, it certainly would not have been easy to stick with them.
This game is hard enough – obsessing over performance relative to benchmarks too frequently makes it almost impossible.