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  What Are the Odds of Selecting a Top Performing Mutual Fund?

Short-Term Performance versus Long-Term Goals

During periods of extreme market volatility, investors often make irrational decisions that can undermine their long-term objective of accumulating wealth and minimizing risk. Since the crash of 2008, financial markets have experienced several periods of market volatility. As a result, investors have become increasingly sensitive to the volatility of the equity market even as we hit record high levels. When investors allow their emotions to guide their investment decisions, short-term market volatility can lead them to abandon their long-term goals in an effort to chase performance returns by engaging in market timing.

When evaluating an investment manager, many individual investors tend to focus on a strategy’s recent performance without understanding the underlying factors that affect a manager’s returns, such as their investment philosophy, investment style and the current market environment. In fact, it is often the case that investors will abandon one investment manager to add another with better recent performance, only to miss out on the abandoned manager’s upside recovery.

To help demonstrate the dangers of chasing performance and market timing, Wilshire conducted a study that followed the best and the worst performing U.S. Large Cap Core equity mutual funds, defined as the top and bottom 25% ranking in the Morningstar Large Cap Core mutual fund universe, over the past 10-year period ending 12/31/16. During this timeframe, there were periods where even the most skilled managers suffered a three-year period of poor peer ranking, and, inversely, where the bottom performing managers demonstrated superior peer ranking. The results, detailed later, strongly reinforce that short-term performance cannot be relied upon for meeting long-term goals.

As depicted in Exhibit 1, over the 10-year period ending 12/31/2016, 97% of the top performing mutual funds experienced a three-year period where they lagged half of their peers. Of these funds, 66% fell to the bottom quartile of the universe, and 39% fell to the bottom decile of the universe, trailing 90% of their peers for at least one three-year period.

Percentage of Top Quartile Managers That Fell in Rankings

  • 97% of these top funds’ rankings fell to the bottom half of their peers
  • 66% ranked among the bottom quartile of their peers
  • 39% ranked in the bottom decile of their peers

While these top performing mutual funds all experienced periods of relative underperformance at some point during the ten-year period of the study, they proved to be the best performing funds during that period.

As investors sell out of their current investments looking for a recent top performing fund, they may find themselves victim to performance chasing. As the above analysis shows, long-term future outcomes cannot be determined solely by short term performance.

The next portion of Wilshire’s study follows the worst performing mutual funds over the past ten years to identify if there were three-year periods where investors may have found them appealing.

Percentage of Bottom Quartile Managers That Rose in Rankings

  • 99% of these bottom funds’ rankings rose to the top half of their peers
  • 84% ranked among the top quartile of their peers
  • 62% ranked in the top decile of their peers

Exhibit 1: Top and Bottom Long-Term Performers

As the study demonstrates, while these funds underperformed over the long-term, there were three-year periods where they outperformed many of their peers. In fact, nearly half of them outperformed 99% of their peers for at least one three-year period.

As we can see from this analysis, short-term performance can be an unreliable method for making critical investment decisions. History has shown us that there will always be times where even the most skilled investment managers will trail their peers, sometimes drastically, for one reason or another. Wilshire’s Manager Research group looks beyond the returns to understand what forces and idiosyncrasies are driving an investment manager’s performance. Wilshire employs proprietary analytics to examine the underlying stock and sector decisions made by investment managers, analyzes the payoff of the active risk being taken, and holds frequent meetings with investment managers to stay up to date on team changes that may impact their investment strategy. All of Wilshire’s research efforts are aimed at measuring an investment manager’s skill and ability to deliver consistent alpha over the long-term, without just looking at short-term performance.

Recognizing the importance of being patient and staying committed to long-term goals, Wilshire’s due diligence on investment managers may help remove emotion from the decision making process, which may help investors in meeting their longterm investment goals.

Wilshire Funds Management (“WFM”) is a business units of Wilshire Associates Incorporated (“Wilshire®”). WFM delivers Wilshire Advisor Solutions, which include models designed to provide a broad range of outcome-oriented investment solutions for advisors to use with their clients. Wilshire is a registered service mark of Wilshire Associates Incorporated, Santa Monica, California. All other trade names, trademarks, and/or service marks are the property of their respective holders.

This material is intended for informational purposes only and should not be construed as legal, accounting, tax, investment, or other professional advice. Past performance does not guarantee future returns.

This material represents the current opinion of Wilshire based on sources believed to be reliable. Wilshire assumes no duty to update any such opinions. Wilshire gives no representations or warranties as to the accuracy of such information, and accepts no responsibility or liability (including for indirect, consequential or incidental damages) for any error, omission or inaccuracy in such information and for results obtained from its use. Information and opinions are as of the date indicated, and are subject to change without notice.

© 2017 Wilshire Associates Incorporated. All rights reserved.

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MORE IN THIS CATEGORY: Manager Research, White Papers

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