Chasing Mutual Fund Performance
Follow the Momentum?
September 2018. Reading Time: 10 Minutes. Author: Nicolas Rabener.
SUMMARY
- Mutual funds exhibit momentum when measured by their one-year performance
- Momentum disappears when more reasonable fund selection criteria are applied
- Performance does not seem effective for fund selection for a full market cycle
CHASING PERFORMANCE
Chasing mutual fund performance suffers from a bad reputation these days. Of course, perspectives change all the time in finance. What was once considered poor form often becomes best practice and vice versa. Leveraged buyouts and activist investors, for instance, were once looked down on by much of the sector, but today their milder incarnations are staples of pension fund portfolios and are perceived as forces of good, not evil.
So maybe investing in the best-performing mutual funds isn’t a bad strategy. It is certainly a popular one. The question is, how does mutual fund momentum chasing play out in the US market?
CLASSIC MOMENTUM
To answer that, we looked at US equity mutual funds from 2000 to 2018 and created long-only portfolios composed of the top and bottom 10% of funds. We then replicated classic equity momentum strategies, selecting mutual funds based on their performance over the previous 12-months and rebalancing the portfolio on a monthly basis (read Momentum Variations).
We found the best-performing funds beat an equal-weight index of all equity mutual funds as well as the worst-performing funds by a handsome margin. Put another way: Performance chasing works.
