active fund managersIf you’ve read any of my previous articles, you know I’m not a fan of active management. The numbers show that it simply doesn’t work. There are several arguments against active fund managers, but one of the most damning is that winners don’t seem to repeat.

Past performance doesn’t indicate future performance – it’s not just something the killjoy lawyers make everyone say. What someone did in the past doesn’t tell you what they will do going forward (outside of some specific situations).

Individual active managers could potentially beat the market consistently (though it’s tough to identify which ones will beforehand). But this lack of persistent outperformance is the most persuasive argument that active fund managers do not have a widespread ability to beat the market.

If people could beat the market – even if they were just more likely to beat the market than others – this would show up in the persistence data. If someone has actual skill, it doesn’t just go away after a couple of good years, right?

But that’s not what the numbers show. It turns out it’s largely random which funds win and which funds don’t.

Let’s look at the data. Last year, Dimensional Fund Advisors did a study to put some numbers around long-term subsequent performance .(1) The study looked at three initial periods – a three-year window (2008-2010), a five-year window (2006-2010), and a ten-year window (2001-2010) – and then looked at how the winners (funds that beat their respective benchmark) did in the subsequent five-year period (2011-2015).

Let’s start at the top with the three-year window. They began with 3,016 funds at the beginning of 2008, and 931 (31 percent) of them beat their benchmark over the entire period (not necessarily every year, but overall). Of those 931 “winners,” 326 (35 percent) beat the benchmark over the next five years.

active fund managersThe graph shows the proportion of funds that outperformed and underperformed their respective benchmarks (i.e., winners and losers) during the initial periods. Winning funds were re-evaluated in the subsequent period from 2011 through 2015, with the graph showing the proportion of outperformance and underperformance among past winners. (Fund counts and percentages may not correspond due to rounding.) Past performance is no guarantee of future results. US-domiciled mutual fund data is from the CRSP Survivor-Bias-Free US Mutual Fund Database, provided by the Center for Research in Security Prices, University of Chicago.

Of the funds that began the period, only 11 percent beat their benchmarks in both periods. You would expect better results if it was just a coin flip. In fact, if active fund managers had the success rate of a coin flip, 25 percent of them would beat the market over both periods. That didn’t happen.

Remember, in the second period we’re throwing out all of the funds that have no chance of beating their benchmark. So that means we’re dropping the index funds (or at least the ones that didn’t screw up and have a huge amount of tracking error) and all the funds with massive expense ratios.

The results here are pretty striking. Even after we dropped the no-hoper funds, the rate of “winning” funds is about the same in both periods. Again, if there is some skill, we would expect to see a much higher percent of funds beating their benchmarks in the second period.

That “winning” group in the second period should be like the Olympic basketball team. The cream has risen to the top and now they’re ready to show what the real pros can do. They’ve already shown they can beat their benchmarks – they just need to do it again.

Some did, but  the percent of winners who beat the market isn’t substantively different from what we saw in the initial period. This is like expecting the Dream Team of 1992 and getting the “Dream Team” of 2004.

We see the same pattern with the five-year initial window (2006-2010). There were 2,730 funds at the beginning of 2006, and 738 (27 percent) of them beat their benchmarks in the first period. Of those 738 winners, 244 (33 percent) beat their benchmarks in the subsequent period.

active fund managersThe graph shows the proportion of funds that outperformed and underperformed their respective benchmarks (i.e., winners and losers) during the initial periods. Winning funds were re-evaluated in the subsequent period from 2011 through 2015, with the graph showing the proportion of outperformance and underperformance among past winners. (Fund counts and percentages may not correspond due to rounding.) Past performance is no guarantee of future results. US-domiciled mutual fund data is from the CRSP Survivor-Bias-Free US Mutual Fund Database, provided by the Center for Research in Security Prices, University of Chicago.

Everything I said about the three-year period applies to this period as well – a slightly smaller number of funds lost in the initial period, but nothing huge. What is interesting, though, is the percentage of the winners that won in the subsequent period was pretty much the same – 35 percent vs 33 percent.

Looking at the longest time period – the ten-year initial window – we see the same basic pattern. Of the 2,758 funds that were around in 2001, only 541 (20 percent) beat their benchmark. And of the winners, 200 (37 percent) did it again.

active fund managersThe graph shows the proportion of funds that outperformed and underperformed their respective benchmarks (i.e., winners and losers) during the initial periods. Winning funds were re-evaluated in the subsequent period from 2011 through 2015, with the graph showing the proportion of outperformance and underperformance among past winners. (Fund counts and percentages may not correspond due to rounding.) Past performance is no guarantee of future results. US-domiciled mutual fund data is from the CRSP Survivor-Bias-Free US Mutual Fund Database, provided by the Center for Research in Security Prices, University of Chicago.

Just like with the other groups, a little more than one-third of the winners beat their benchmarks from 2011-2015. In other words, almost two out of three winners lost in the subsequent period.

These are supposed to be the Larry Birds, Michael Jordans, Scottie Pippens, and John Stocktons of fund managers, yet somehow almost two-thirds of them lost that magic touch. That’s not a team I would want to bet on.

For more on how to get the most out of your portfolio, take a look at our ebook, “12 Principles of Intelligent Investors”.

(1) I previously worked at Dimensional, my father is on the board of directors, and both my sister and her husband work there.

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