I’ve been reading and writing a lot about active fund management since I started this blog. In addition to high fees and overall under-performance, I’ve also written about how funds that have performed well in the past tend to perform poorly in the future–i.e. reversion to the mean. Now Vanguard has backed me up:

Image courtesy of Vanguard and Business Insider.

The table compares different quintiles of funds based on their performance from 2006-2010 and then looks at how those funds performed from 2011-2015. Some observations: the top 20% of funds from 2006-2010 were 50% more likely to be part of the lowest quintile of funds in the future compared to any other group. The lowest quintile of funds were equally likely as any other group to be the best performing over the next 5 years, but were also the most likely to be merged or closed.

We can draw a few lessons from this table. One, reversion to the mean is alive and well, especially for funds that have performed well recently. No one has a crystal ball, and whatever happened in the market that worked well for the fund manager is not likely to work well in the future, as there is much more luck than skill involved. Second, funds that have performed poorly are most likely to be closed in the future, which will return your funds to you along with possibly a tax mess. This happens so that the fund management companies can stem the outflows of money (i.e., their revenue) and hide that past poor performance going forward. The funds that aren’t closed, however, are about as likely to do well in the future as any other fund. Finally, don’t chase winners in active mutual funds, but also don’t chase losers. In fact, it is probably best that you don’t buy any actively managed mutual funds, as their higher fees and taxes are overwhelmingly likely in the long run to more than offset any benefit provided by active stock picking.

-Richard

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