A new study has reinforced the maxim that past performance is a poor indicator of future performance, reinforcing the need for investors to consider how long they give a fund manager to perform.
The study, conducted by Frontier Advisors, found that the average fund managers deliver small and inconsistent outperformance and can underperform for longer periods than most people think.
The research found that the average Australian and global equity fund manager delivered outperformance of less than one per cent a year, after fees, suggesting that there is a low margin of error for active managers.
It also found that active managers commonly underperformed for around four years over an equity product’s lifetime.
Commenting on the research, Frontier Advisors Consultant, Zong Aw, said the study reinforced the need for investors to rebalance their portfolios as even strong performing products that they wanted to invest with over the long term experienced multi-year underperformance periods in their lifetime.
“Trimming would help you avoid those situations where your managers experience a reversal in performance, so you can capture some of the outperformance, rather than giving it away when that cycle turns,” he said.
The Frontier study found significant “reversion to the mean” effects on fund manager investment returns.
For example, the lowest-quartile performing managers in Australian large and small cap equities over a three-year period had around a 40 per cent probability of reverting to the top quartile in the following three-year period.
Conversely, a top-quartile small cap manager over a three-year period had about a 50 per cent chance of falling to the bottom quartile in the following period.
In contrast, upper quartile global equity managers had around a 40 per cent chance of maintaining their top performance in the following three-year period but an almost 40 per cent chance of then dropping to the bottom quartile in the next three-year period. Frontier suggested that much larger style factors in global equities were a likely driver of this different pattern of global equities active manager returns. This highlighted that investment styles go in and out of favour and Frontier suggested a global equities portfolio should also be rebalanced to maintain a balance of investment styles.
Aw said the study reinforces a second significant finding that investors commonly hear: past performance is a poor indicator of future performance.
“If the only reason to retain a manager and let an allocation build over time is past performance alone, this study shows that it is not a very good strategy, which again emphasises the need to rebalance your portfolio.”
