Beware of Statistics

Have you ever bought into an investment strategy or mutual fund with a stellar track record only to experience disappointing returns subsequently?

A sample of actively managed U.S. equity mutual funds from the Morningstar Direct database from January 1991 to June 2020 shows that, on average about 100 of the funds available at the beginning of any given year disappear (they are liquidated or merged).

One study shows that over the period 1991 to 2020, the median fund alpha of actively managed US equity mutual fund detracted -0.84% per year. This only accounts for funds that have survived and remained in business. If we were to take into account all actively managed US equity mutual funds, the median fund alpha falls to -1.44% per year. That is almost a 50% difference.

What can investors do?

The evidence is clear. Over 90% of large-cap active funds underperformed the S&P 500 over the past 20 years¹. When compared to the S&P 500 Equal Weight Index, which can be a proxy for stock-picking since it differs from a market-cap weighted index, this figure rose to nearly all (99%) of actively managed funds underperforming over a 20-year period².

Survivorship bias in data shows a skewed view of reality, overstating positive outcomes and understating bad outcomes.

Investors can use this information to help them make better decisions. Instead of focusing on a fund that has stellar historical performance, consider whether the manager is able to replicate the performance in the future. A better representation of this ability is to test whether the performance has been consistent across the full set of funds, including funds that are no longer available for investment — otherwise, what might seem like extraordinary stock-picking skill may, in fact, be a skewed representation of reality.

Past performance might give us a clue as to the manager’s capability but it is insufficient to make a proper evaluation. A robust strategy design, sound investment philosophy and efficient portfolio management and processes are necessary to have a good investment experience and allow investors to achieve their goals.


There is a better way to invest

Experience the difference today with a wealth manager that is aligned with your interests.

GYC applies the best ideas from financial science to develop a financial plan that is built upon a rigorously tested investment philosophy.

 

¹See Ganti, Anu, Davide Di Gioia, Tim Edwards, Sabatino Longo and Joseph Nelesen, “SPIVA U.S. Year-End 2023,” S&P Dow Jones Indices LLC, March 6, 2024.

²See Tim Edwards, Anu, Hamish Preston, “Worth the Weight,” S&P Dow Jones Indices LLC, July 2024

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