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Study shows (again) that mutual fund hot hands quickly cool

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As if we needed another study to spell this out, S&P published a recent study (.pdf) that undermines the hot money chasing performance in the mutual fund industry.  The study shows that very few funds demonstrate persistence — the ability of asset managers to consistently achieve top-quartile or top-half performance.

The amazing take-away from the study:

Over the five years ending September 2009, only 4.27%
large-cap funds, 3.98% mid-cap funds, and 9.13% small-cap funds maintained a top-half ranking over the five consecutive 12-month periods. No large- or mid-cap funds, and only one small-cap fund maintained a top quartile ranking over the same period.

Couple of things here:

  • Not one large-cap or mid cap fund maintained top quartile ranking.  Should investors just use large cap and mid cap indices for their exposure here regardless?
  • While still posting rather poor results, there are twice the percentage of small cap funds achieving top-half performance than large caps.  There still seems to be significantly more value in active portfolio management in the small cap arena.

The study’s ultimate takeaway:

Our research suggests that screening for top-quartile funds may be inappropriate.A healthy plurality of future top-quartile funds comes from the prior period’s second, third and even fourth quartiles. Screening out bottom quartile funds may be appropriate, however, since they have a very high probability of being merged or liquidated.

Compare that to the findings of Jagannathan, Malakhov, and Novikov in “Do Hot Hands Exist Among Hedge Fund Managers?”:

We find evidence of persistence in the performance of funds relative to their style benchmarks. It appears that on average more than 25% of the abnormal performance during a three year interval will spill over into the following three year interval.

[Hat tip: Pragmatic Capitalist]

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