August 27, 2014

Vanguard Quantifies the Impact of Chasing Performance

“For investors using active management, it’s critical to understand that short-term performance should not be the sole reason to enter or exit a mutual fund. To improve their chances of succeeding with active funds, investors must be willing and able to avoid the ‘thrill of the chase.’”

“Past performance does not guarantee future results.” How many times have your eyes glossed over that phrase, a disclaimer so ubiquitous that it doesn’t even register anymore? There’s a reason those seven words appear on almost all financial publications! Investors do tend to chase performance — that is, they will sell funds that aren’t performing well while buying funds that show better performance.

The thing about all that performance? It’s in the past!

Vanguard recently completed a study, “Quantifying the impact of chasing fund performance,” on how chasing performance can affect an investor’s long-term returns. The results, while perhaps not surprising, are a good reminder that long-term investing should be more about discipline and strategy than about chasing numbers. In every scenario they studied and in every asset class, spanning 2004 to 2013, a buy-and-hold strategy delivered superior performance relative to a performance-chasing strategy.

Investors know that past performance is in the past and doesn’t indicate what the future will be, which is why the disclaimer is ignored as common sense. But the impulse to chase after past performance is strong and intuitive, and an easy trap to fall into. The Vanguard study is a helpful reminder that short periods of underperformance in active strategies are inevitable, and not necessarily a call to action. Long-term investors will be better served by discipline and prudence than short-term return hunting.

“Buying actively managed mutual funds based on a combination of qualitative and quantitative factors and then maintaining a disciplined approach and long-term perspective despite fluctuations in manager performance has been a simpler and more effective approach for increasing returns than chasing active manager performance.”

You can read or download the full study HERE.

 

Source: “Quantifying the impact of chasing fund performance” by Brian R. Wimmer, CFA; Daniel W. Wallick; and David C. Pakula; Vanguard Research; 2014