Near Term Performance is Predictive
Choosing Funds by Near Term vs Long Term Returns
‘Persistence of Performance’
Many investors focus on long term performance
records when selecting mutual funds. But
in our 40+ years of managing mutual fund portfolios,
we’ve found that investors are better off
choosing funds by near-term performance. Funds
that have done well over the near-term tend to
do well in ensuing months, a phenomenon called
‘persistence of performance’.
Our Upgrading investment strategy looks at
four current performance periods to select funds,
ranking funds by an average of the trailing 1, 3,
6, and 12-month returns. This combination isn’t
perfect of course, but it beats any other fund selection
method we’ve tested.
We regularly test alternate ways of ranking
funds. We’ve looked at the effect of including
certain time periods and excluding others. We’ve
looked into weighting the returns of some periods
and not others. If there’s a better alternative, we
still haven’t found it.
Near Term vs Long Term
Our research shows that the longer-term the
performance period was, the less predictive it was.
The chart, below, details the results of our most
recent study and the results are the same: combining
the 1, 3, 6, and 12-month returns still led to
higher returns than selecting funds by their 3 or 5
year records.
For the 10+ year time period, shown below, a
portfolio that invested based on a fund’s 1, 3, 6,
and 12-month returns produced 8.06% annualized,
while investing in the funds with the top
3-year returns only gained an annual 2.23%. Using
trailing 5-year records to select funds returned just
1.34% annualized.
All of these Upgraded portfolios beat the market,
however: the S&P 500 had an annualized
return of negative 0.2% for this time period.
