Buying Mutual Funds based on previous results, in general, is a good approach

[Soon to be free]

Look at any business magazine and you will find advertisements for Mutual Funds. The main thing they advertise is how successful the fund has been in the past. They also advertise the quality of the fund company and the managers of the mutual fund.

For example, most people like Vanguard Wellesley and Wellington because they have a good track record. Their managers have been successful at buying and selling stocks and bonds within the fund historically that have given them better returns than the peer funds for years and years.

Now is it possible in the future that the Vanguard Wellesley and Wellington Mutual Funds will crash and burn significantly more than the benchmark of similar funds? Sure, it is possible. But due to historical successes year after year after year, it is unlikely. (Some superstar funds have crashed and burned but the odds are low.)

So why do so many people say it is a bad idea to purchase mutual funds based on Morningstar rates, historical success, and the reputation of the fund company and the managers of the mutual fund?

 

[pb4uski]

Who says that?

OTOH, all you have to do is to look at the history of Fidelity Magellan to see a great example of why past performance is not indicative of future results.

IMO, you need to look at past performance, the fund's objectives and philosophy, management, managerial stability, etc.. which is why indexing is easier... I'll get whatever the market/index does.

 

[REWahoo]

I smell a troll.

Soon to be free, do these user names ring a bell?

- Glad to be Retired
- Early SS
- Forced to Retire
- Waiting for Pension
- Retired and Restless

 

[Onward]

So why do so many people say it is a bad idea to purchase mutual funds based on Morningstar rates, historical success, and the reputation of the fund company and the managers of the mutual fund?

Soon to be free, is your real name Bill Miller?

 

[pb4uski]

 

[OldShooter]

... So why do so many people say it is a bad idea to purchase mutual funds based on Morningstar rates, historical success, and the reputation of the fund company and the managers of the mutual fund?

Troll or not, I'll answer: Because all the statistical data say that this is a complete waste of time.

S&P publishes a "Manager Persistence Report Card" every six months. This statistical study consistently shows that being a top manager in one period is not predictive. https://us.spindices.com/documents/spiva/persistence-scorecard-june-2017.pdf

The WSJ published an article a few weeks ago after studying 1,500 Morningstar 5-star funds and the conclusion was that a 5-star rating is not predictive. "[FONT=&quot]The Morningstar mirage: What those fund ratings really mean" 10/26/17 Unfortunately it is behind their paywall, but many summaries like this one are available in the wild: Morningstar Star Ratings, Still Less Useful Than Expense Ratios — My Money Blog

Gurus Fama and French attempted to find a way to predict manager performance and faile[FONT=&quot]d[/FONT]. French discusses their paper here: https://famafrench.dimensional.com/videos/identifying-superior-managers.aspx The paper itself is here: https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1547393_code998.pdf?abstractid=1356021&mirid=1

There is only one predictor that I know of: fees. Low fees are correlated with higher performance, but this is a [FONT=&quot]uselessly [/FONT]blunt tool for selecting a manager. Fund Fees Predict Future Success or Failure

Bottom Line: Active managers' performance is basically due to luck and trying to select a manager who will be lucky in the future is futile.[/FONT]

 

[VanWinkle]

no comment, being trolled again.

 

[flintnational]

It was enough to convince me. I sold all my index funds and bought all five star Morningstar funds. What could possibly go wrong. And, Morningstar will refund my money if it does not work out. Right?

 

[MRG]

I'm long SEQUX for thirty five years. What could possibly go wrong?

 

[OldShooter]

I'm long SEQUX for thirty five years. What could possibly go wrong?

Actually, that's quite a good example. Schwab's data only goes back ten years, but the SEQUX 10-year return is 6.36% and the S&P 10-year return is 7.51%. So SEQUX's shortfall of 1.15% is only a bit more than its current 1.07% fee. This is quite good for a stock-picking fund and almost exactly what William Sharpe predicted in his 1991 paper "The Arithmetic of Active Management." (https://web.stanford.edu/~wfsharpe/art/active/active.htm) Probably this is due to their relatively low portfolio turnover of only 16% per Morningstar. It's a little hard to eyeball its year-to-year variation but it looks to be smoother than most stock-pickers' performance. So ... if one wants to hire a stock-picker, there are a lot of worse choices than SEQUX.

 

[mathjak107]

actually it can be true . the only problem is like whjat happened with magellan, is that when something like the manager changes it may n longer be the same fund .

which is why 90% of my investing has always been dynamic .

when things change the fund is swapped .

a study by morningstar showed that it is not the fact that managers can't beat the markets . it is that many funds with goods stock pickets funds are small and while the stock picking is good the expense of running a small fund makes it hard to get keep the alpha .

however morningstar found if you take the 25% lowest cost funds , which generally are the biggest funds with most investor money , they tended to beat their index's over time more often than not .

but when managers change they are not the same fund anymore .

 

[Chuckanut]

Now is it possible in the future that the Vanguard Wellesley and Wellington Mutual Funds will crash and burn significantly more than the benchmark of similar funds? Sure, it is possible. But due to historical successes year after year after year, it is unlikely. (Some superstar funds have crashed and burned but the odds are low.)

So why do so many people say it is a bad idea to purchase mutual funds based on Morningstar rates, historical success, and the reputation of the fund company and the managers of the mutual fund?

IMHO, the idea that past history is more important than low fees is false. If Wellesly and Wellington continue to do well compared to other similar funds it is because their fees are low, and not because their past history looks good. My 2¢.

 

[OldShooter]

... a study by morningstar showed that it is not the fact that managers can't beat the markets . it is that many funds with goods stock pickets funds are small and while the stock picking is good the expense of running a small fund makes it hard to get keep the alpha .

however morningstar found if you take the 25% lowest cost funds , which generally are the biggest funds with most investor money , they tended to beat their index's over time more often than not ...

If you're referring to this study: Fund Fees Predict Future Success or Failure I don't think it says anything at all about funds beating indexes or benchmarks.* The author defines "success ratio" as " ... the success ratio asks, 'What percentage of funds survived and outperformed their category group?' " IOW, "success ratio" compares a fund only to other funds.

With Morningstar, I have found that they have a strong tendency to compare fund performance with other funds' performance. In a way, this is like selecting the tallest midget.

I think that their result makes sense, though. After all, the lowest cost funds are going to be the passive funds, aka "index funds," and they do consistently beat their fund peers. No news there, really. But, importantly, they still underperform their benchmarks slightly due to fees, however small.

If you can point me to data that says that the lowest cost funds "tended to beat their index's over time more often than not" I would be very interested to see it.

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*A text search of the web page and the PDF version of the article shows that neither the word "index" nor the word "benchmark" appear.