Using a survivor bias free mutual fund database, S&P Global Research reports that using the past five years’ annual returns as well as cumulative five-year historical returns to find future winners is roughly equivalent to rolling the dice.
Over the five years ending September 2009, only 15 (4.27%) large-cap funds, 7 (3.98%) mid-cap funds, and 21 (9.13%) small-cap funds maintained a top-half ranking over 5 consecutive 12-month periods. No large- or mid-cap funds, and only one small-cap fund, maintained a top-quartile ranking over the same period.
So, if selecting funds based on short-term performance, even 5-year performance, isn’t the key to finding future winners, what is? When seeking to select winning strategies, there is no substitute for looking at much longer-term performance histories and doing the necessary due diligence to understand why a given active investment approach is likely to persist in generating excess returns in the future. Then, once an active strategy is selected, expect periodic periods of short-term underperformance.
