van Eyk Head of Asset Consulting Jonathan Ramsay said an analysis of top performing managers showed that fund outperformance very rarely lasted for more than a few years before it petered out, or worse, took some or all of that outperformance back by underperforming the market index. 

Since the flow of funds from investors into an outperforming manager typically grew exponentially as its level of outperformance increased, most money would flow into the fund as its performance was peaking. 

“By weight of money many investors in these funds will end up being disappointed”, Mr Ramsay said. 

The analysis was based on a list of core, style neutral Australian equity funds which had outperformed the Australian equity market by five per cent per annum at some point over the last 20 years. This was the “crème de la crème” of Australian equity funds, Mr Ramsay noted. In fact, only ten funds met that performance standard. 

The performance of these funds showed that even though their outperformance could go on for a number of years, they all either went on to have long periods of underperformance, or at best, performed in line with the market. 

Mr Ramsay said the problem with previous studies on persistency in fund performance was that they used average measures of performance or the results were highly dependent on the time horizon chosen. “We took a closer look at whether any individual managers had actually provided persistently strong outperformance or whether they had just managed to catch a market wave, a wave which inevitably subsides,” he said.

Mr Ramsay said the only way investors could reliably take advantage of a strongly performing fund was to try to predict periods of outperformance and invest before it occurred rather than chasing the chimera of past performance. 

He said fund outperformance tended to be episodic and investors needed to take into account more than how good a manager and their investment process was. “Stock-selection doesn’t happen in a vacuum and having a view about the market and the interaction between that and a manager’s investment process is very important,” Mr Ramsay said. 

He said the notable achievement of the best and most enduring funds management organisations was avoiding underperformance when markets were subdued while being able to catch the next market wave when it came along.

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