“Past performance is no guaranty of future performance” — how many times have we heard that?
Standard & Poor’s just released a report on “persistence” or how long does a high performing mutual fund continue to perform so well. They looked at all 546 equity mutual funds that were in the top quartile (top 25%) of March 1st, 2017 and compared them to the same date two years later. Of those 546 funds, only 11.36% of the funds remained in the top quartile.
More interesting, there was a big difference between large-cap funds and small-cap funds. Of the 206 large-cap funds, only 5.38% remained in the top 25%. Of the 133 small-cap funds, 23.31% survived to remain in the top 25%. In other words, small-cap funds had greater persistence than large-cap funds. If you absolutely, positively want to rely on past performance as an indicator of future performance, consider doing that only for small-cap funds.
(In all fairness, that relationship of better persistence for small-cap funds is true for the two-year period but not for the five-year period. Intuitively, I suspect the two-year survey is more representative, due to the impact of media on large-cap stocks. This research still needs to be done.)
Of course, the reason for any lack of persistence is usually risk. If the fund takes considerable risk now, it will likely have better performance only in the short-term but probably not in the long-run. There are numerous means to estimate risk, but mutual funds usually report only their Sharp Ratio, which measures return earned per risk assumed. A higher Sharp Ratio is better than a lower one. So, when a financial advisor shows you two funds with the same performance, ask which has the higher Sharp Ratio.
Of course, now bow your head, close your eyes and repeat after me . . . past performance is no guaranty of future performance, regardless of its Sharp Ratio!