Investors chase tomorrow’s feather duster

Today's stars are often tomorrow's average performers.

But that has not stopped star performers continuing to be the investor's first choice, according to a recent study in the US.

The study by Financial Research found that over the past decade, picking last year's top performing managed funds was often a recipe for disaster but the highest-ranking funds continued to attract an increasing amount of money from investors.

The top 10 per cent of funds in any year since 1988 fell to the 48th percentile in the following year, on average. And the bottom 10 per cent climbed to the top half, according to James Crandall, an analyst at Boston-based Financial Research Corp.

"Basically, they revert to the mean," says Crandall, citing the results of the study on predicting fund performance of equity funds. The findings highlight the perils of choosing funds based on past performance, he says.

The same phenomenon was graphically illustrated in Australia last year by Tyndall. The group was riding high on its stellar investment performance in Australian equities in 1997 when its value style shot it to second place in the Money Management's Fund Manager of the Year. Last year turned out to be one of the rare bad years for value styles which has sent Tyndall's performance languishing in the bottom quartile of returns.

But the message that fund managers do not usually stay at the top for too long doesn't seem to be getting through to investors. The funds ranked highest by Morningstar, which make up just 18 per cent of the 7,075 stock and bond funds sold in the US, took in almost three quarters of the $340 billion of new investments last year, according to Financial Research figures.

The number of fund introductions fell 43 per cent last year, which "means more money will go to managers of the most highly rated existing funds", says Financial Research analyst Raymond Liberatore.

The problem with investing with last year's stars is the difficulty to repeat the right choices in terms of industry sectors and market capitalisation. Besides, the high-fliers are "deluged with cash", making it even more difficult to deploy that money as successfully as before, Crandall says.