Why did that top performing mutual fund hit the skids right after you bought in? Because you, along with about a gazillion other performance chasing investors, flooded it with more money than it could handle. Mark Hulbert in the New York Times reports on a study by Berekely finance professor Jonathan Berk which argues that the main reason most top performing funds can't continue their winning ways over the long term is that they become overwhelmed with new investor money.
The reason that so few mutual funds beat the market over the long term is that investors shift too much money into the successful ones, or so the theory goes. As a result, these funds’ managers quickly become swamped with more money than they can invest profitably, causing performance to suffer.
A helpful analogy, Professor Berk said in an interview, is to the so-called Peter Principle, which predicts that employees will be promoted until they reach their level of incompetence. Similarly, a mutual fund manager who beats the market will continue to attract more assets until he can no longer beat the market."
Unfortunately, while funds with outstanding recent performance is usually followed by a period of underperformance, lousy past performance is not a predictor of good things to come:
This theory has been less successful, however, when applied to the worst-performing mutual funds. Less-able managers should become competitive once their portfolios become small enough, because, according to Professor Berk, it is easier to beat the market with a smaller portfolio than with a larger one. So, as investors shift money out of a lagging fund, its size should stabilize at whatever lower level is necessary to give its manager a fighting chance of beating the market.
If this part of the theory were right, the worst performers would be no more likely to stay bottom-ranked than top performers to remain top-ranked. But that is not the case, according to the professors. A low-ranking performer, in fact, has a significantly greater chance of continuing to be a low-ranking performer than a top-ranking performer does of staying at the top."
Berk believes that poor performers continue to perform poorly because investors tend to stick with these dogs instead of selling. "By not selling, this loyal group prevents poor performers from becoming small enough that their managers can become competitive again."
Are you guilty of buying last year's winning funds, only to see them turn into this year's losers? The MAXadvisor Powerfund Portfolios can help. Click here to learn more.
Why did that top performing mutual fund hit the skids right after you bought in? Because you, along with about a gazillion other performance chasing investors, flooded it with more money than it could handle. Mark Hulbert in the New York Times reports on a study by Berekely finance professor Jonathan Berk which argues that the main reason most top performing funds can't continue their winning ways over the long term is that they become overwhelmed with new investor money.
The reason that so few mutual funds beat the market over the long term is that investors shift too much money into the successful ones, or so the theory goes. As a result, these funds’ managers quickly become swamped with more money than they can invest profitably, causing performance to suffer.
A helpful analogy, Professor Berk said in an interview, is to the so-called Peter Principle, which predicts that employees will be promoted until they reach their level of incompetence. Similarly, a mutual fund manager who beats the market will continue to attract more assets until he can no longer beat the market."
Unfortunately, while funds with outstanding recent performance is usually followed by a period of underperformance, lousy past performance is not a predictor of good things to come:
This theory has been less successful, however, when applied to the worst-performing mutual funds. Less-able managers should become competitive once their portfolios become small enough, because, according to Professor Berk, it is easier to beat the market with a smaller portfolio than with a larger one. So, as investors shift money out of a lagging fund, its size should stabilize at whatever lower level is necessary to give its manager a fighting chance of beating the market.
If this part of the theory were right, the worst performers would be no more likely to stay bottom-ranked than top performers to remain top-ranked. But that is not the case, according to the professors. A low-ranking performer, in fact, has a significantly greater chance of continuing to be a low-ranking performer than a top-ranking performer does of staying at the top."
Berk believes that poor performers continue to perform poorly because investors tend to stick with these dogs instead of selling. "By not selling, this loyal group prevents poor performers from becoming small enough that their managers can become competitive again."
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Are you guilty of buying last year's winning funds, only to see them turn into this year's losers? The MAXadvisor Powerfund Portfolios can help. Click here to learn more.