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Monday, February 1, 2010

Is This Actually News to Anyone ? You Can't Pick Hot Fund Managers In Advance

I have a thick file folder of articles on this point but in case this is news to anyone I thought I would highlight this article from the WSJ. Not surprisingly the folks from Morningstar try to spin in both ways and someone from a major brokerage firm tries to argue otherwise. But the bottom line remains the same it is virtually impossible to pick top mutual fund performers based on past data because there is little persistence in manager outperformance . The logical conclusion from the above is that mutual fund manager outperformance is just as likely to be the product of luck as it is to likely to be evidence of superior skill.

my bolds my comments in blue

With Fund Managers, Past Is No Predictor for Future

New studies cast doubt on whether fund-manager skill and past performance are good gauges of future results.
Advisor Perspectives, an e-newsletter for financial advisers, in December published a study suggesting that investment research firm Morningstar Inc.'s star ratings, which are based on past returns, don't provide much predictive value. It also found that many five-star-rated funds were likely to underperform their peers.
Robert Huebscher, chief executive of Advisor Perspectives, randomly selected a fund with a particular rating, and then looked at how it fared against randomly selected funds with lower-star ratings from the third quarter of 2006 through the third quarter of 2009. He found many cases where the lower-rated funds were more likely to outperform those with higher ratings.
Yet, despite those findings, "the public pour money into funds that get higher ratings," Mr. Huebscher says.
The perils of banking on past performance are clear to see. Bill Miller, manager of Legg Mason Capital Management Value Fund (trading symbol: LMVTX), posted an industry-record streak of beating his benchmark for 15 straight years. But investors joining the fund in early 2007 based on that record would have suffered a 6.7% loss that year, followed by a whopping 55% decline in 2008. Further illustrating that past performance isn't a reliable guide, the fund was up almost 41% last year....

Morningstar's vice president of research, John Rekenthaler, questions the time frame the study used. But while he disagreed with some of the details, he says he didn't have an issue with the notion that it is hard to use past performance to predict future results.
This is the often seen Morningstar two step: they have some problems with the study that shows their rankings tell nothing about past performance but they agree that past performance tells you nothing about future fund performance.
Can top managers repeat their performance?
According to a Morgan Stanley Smith Barney's Consulting Group study, the very best managers—the top 10%—can repeat their success; at least, they did in three-year periods from 1994 to 2007 covered in the study. But the study also finds that the worst 20% of performers are also likely to outperform in the future.
The study's author, Frank Nickel, says this is because the bottom funds benefit from changing market cycles: Their holdings were out of favor but then get hot and thus outperform. Mr. Nickel says that, rather than picking a fund based on manager ability, which his study concludes does exist, he would rather pick an unloved area of the market and ride its moves to the top.

Now this is an elaborate and obscure way of saying that their data tell nothing about manager performance they simply reflect the changing fortunes of various market sectors or asset classes. It isnt that the  manager was particularly bad in the bad years or good in the good years it's simply (to give an example) that the small cap value manager did very poorly relative to others when small value performed poorly and vice versa. Doubtles much the same would have occurred among various index instruments. We already know from many other studies that few asset managers outperform their relevant benchmarks and in fact when they do it is usually done by straying from their mandate (value found investing in growth domestic into international for example).
Another study contends that, outside the top 3% of funds, active management lags behind results that would be delivered due simply to chance.(which explains why one of my favorite finance books pictured above argues that we often incorrectly attribute results that are a product of luck to management skill)  This study, published late last year by Eugene Fama, professor of finance at the University of Chicago Booth School of Business, and Kenneth French, professor of finance at Dartmouth College's Tuck School of Business, ran 10,000 simulations of what investors could expect from actively managed funds.
Mr. Fama is one of the pioneers of the efficient-market hypothesis—the idea that securities are priced correctly because they incorporate all the known information relating to a company. So the latest study fits his views in finding that very few people can consistently beat the financial markets.

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