Persistence of Outperformance Is a Myth
“If I were a betting man, I would have a higher chance of getting three consecutive heads on a flip of a coin. My chances of success would be higher compared to the chances of me picking a fund that persists its performance for three consecutive years over its benchmark.” –Guarav Sinha, Head of Research and Design at S&P Dow Jones Indices
Probably the way most investors pick mutual funds for their portfolios is based on past performance. Funds that outperform in any given year tend to get the most inflows of new money. Makes sense from a practical point of view. The problem is that persistence of outperformance is a myth.In a recent study by S&P Dow Jones Indices, less that 13% of U.S stock funds that beat their benchmark for the three year period ending 2016 were able to continue to outperform for next three year period ending 2019. Check out the details from a recent article from Institutional Investor.
Picking funds based on past performance is called track record investing. It’s one of the three deadly sins of investing. The other two are stock picking and market timing.
So how can investors avoid track record investing? By having a properly diversified and uncorrelated portfolio that invests in the global capital markets. Essentially investing in global capitalism and not what just happened to do good last year.