Last week, S&P Dow Jones Indices published the results of its March 2015 persistence scorecard. The scorecard tracks the consistency of top performers over yearly consecutive periods and measures performance persistence through transition matrices. The University of Chicago's Center for Research in Security Prices (CRSP) Survivorship Bias Free Mutual Fund Database serves as the underlying data source. To avoid double-counting multiple share classes, only the largest share class of a fund is used.
The persistence scorecard showed that just 17% of U.S. large-cap and mid-cap funds and 23% of small-cap funds maintained a top-half ranking achieved in one 12-month period for two additional 12-month periods (Performance is based on equal weighted fund counts). Relative to the prior September 2014 scorecard, all three of the categories worsened.
If this data and the S&P Dow Jones SPIVA US Scorecard does not encourage you to consider passively managed ETFs such as iShares Core S&P Small Cap (IJR), be mindful that the once hot active mutual funds (those in the top quartile) might very well end up in the bottom quartile soon after. According to the S&P Dow Jones study, of 427 US equity funds that were in the top quartile, 16% moved into the bottom quartile during the five-year horizon. Meanwhile, for bottom quartile equity funds that did not get merged or liquidated, a similar 22% moved to the top quartile over the same period. As such, S&P Capital IQ recommends investors look beyond just a period of relative outperformance or underperformance.
In addition to reviewing holdings, S&P Capital IQ considers tenure of management as well as expenses in assigning its mutual fund star rankings.
In some cases, a mutual fund will experience a management change that will put a halt to its performance success or perhaps turn around its fortunes. However, if you ensure that management has been at the helm during the full time period under consideration, you can feel confident the record is appropriately tied to the current management.
Meanwhile, we contend that part of the underperformance of an actively managed fund stems from its expense ratio. While the average small-cap core mutual fund has a 1.3% expense ratio, there are many funds with lower costs. Since expense ratios eat into investor returns, choosing strong performing funds that cost less increases the likelihood of consistent gains.
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