How To Lose Money In The Market

Do most mutual fund managers add value in their attempts to identify 'mispriced' securities? 

Based on a recent analysis of the CRSP (Center for Research in Security Prices) Mutual Fund Database returns data through 2012, we have a pretty good idea of the answer.

This CRSP report documents survivorship and performance in the U.S. mutual fund industry, and illustrates the negative impact of high fees and turnover on returns.  In summary, for the periods examined:

*Outperforming funds were in the minority
*Strong track records failed to persist
*High costs and excessive turnover may have contributed to underperformance

The underperformance among mutual funds points to an important guiding investment principle:  Choosing a long-term winner involves more than seeking out funds with a successful track record, since past performance offers no guarantee future success.  Investors must consider other variables, including a mutual fund’s underlying market philosophy, investment objectives, and perhaps most importantly, cost. 

The competitive landscape makes the search for future winners a formidable challenge. Confronted with so many fund choices – and lacking an investment philosophy to guide their search – some investors resort to picking funds that have strong track records, reasoning that past outperformers will continue to outpace their benchmarks.

According to the CRSP analysis, only about a quarter of the equity funds with past outperformance during the initial three-year period (2007-2009) continued to beat their benchmarks in the subsequent three-year period (2010-2012).  The results for funds with good five- and seven-year track records were similar – only about a quarter beat their benchmarks in the subsequent period.

So, do most mutual fund managers add value in their attempts to identify 'mispriced' securities?  This CRSP analysis of U.S. mutual fund industry performance tells us the answer is a resounding, "No!"  It’s more proof that a broad, low cost investment approach is the best one.