As market volatility persists and clients switch from growth to income mandates, fewer are holding mutual funds. Last week, investors pulled $1.37 billion out of long-term funds.
But even as some clients leave the mutual fund market, others are holding on. Ensure these investors have high-quality funds and that you’re working with a good manager.
How can you tell if you’ve made the right choice?
Fund companies often imply managers with tenure are also skilled. Jack W. Trifts, finance professor at Bryant University, disagrees.
Alongside Gary E. Porter, associate professor of finance at John Carroll University’s Boler School of Business, he found even the best solo mutual fund managers become worse at their craft over time.
In their paper entitled “The Best Mutual Fund Managers: Testing the Impact of Experience Using a Survivorship-bias Free Dataset,” the two men examined more than 80 years of data to identify the best solo mutual fund managers and the keys to their successes.
They also looked at the relationship between performance and tenure in a sample of 289 managers of 355 actively managed funds.
“There’s a general decline in performance over time because superior results are based on random luck,” says Trifts says. “Fund managers who have high performance early in their careers may be branded as stars at the time, but they do fade.”
He adds, “The longer a manager runs a fund, the higher the likelihood of mean reversion setting in. Even great managers’ performance will suffer.”
The paper suggests fund managers in the business for 10 or more years most often performed at or above the market in their first three years. Despite continuing to generate positive, compound, annual market-adjusted returns, they can’t match earlier stellar performance.
This isn’t great news. Chances are both you and your clients are searching for stable investments and reliable managers to combat tough markets. Those with great track records and good reputations seem like a good choice.
Based on the research, though, avoid depending only on the reputation and past performance of managers when making crucial investment choices. Factor in a decline of their past performance when calculating possible returns, and avoid trying to find the superstar that’ll beat the market.
Star managers may burn out, but good, reliable managers will still produce decent returns for your clients.