Expert FAQ: Do Mutual Fund Managers Improve Over Time?

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Do mutual fund managers improve with experience?  Though perhaps counterintuitive – and unfortunate for many mutual fund investors – new research actually shows that the truth is a lot murkier and more random.

A new study, entitled The Best Mutual Fund Managers: Testing the Impact of Experience Using a Survivorship Bias Free Dataset, looks at historical data spanning over 80 years to find out.  First, they used this dataset to identify the best mutual fund managers with tenure of over 10 years.  They then looked at solo fund managers’ performance over time to find that while a very small contingent of managers was able to outperform the market over this longer timeframe, most of them actually saw declining performance over time.   

Coauthors, Gary E. Porter with the Boler School of Business at John Carroll University, and Jack W. Trifts, Professor of Finance at Bryant University, find that even the most talented individual mutual fund managers actually do worse over time, indicating a large element of luck and randomness at play.

Key Research Findings:

  • Among a sample of 289 solo managers of 355 actively managed funds, the study found “an inverse relationship between average annual returns and tenure”
  • It also found that “The managers who survived more than ten years were likely to have performed at or above the market in their first three years, while their peers who did not survive as solo managers beyond three years significantly underperformed the market”
  • Even managers who continued to do well over time could not maintain their earliest levels of performance

This research supports a recent InvestingNerd study, which shows that over the past 10 years, only 24% of active mutual fund managers outperformed their benchmark index.  It found that, while active managers may have barely outperformed the index by 0.12% before fees, they then charged more in fees than the value they created on average.  As hard as they may try, data shows that over time professionals still have trouble outperforming the market.

Gary E. Porter, Ph.D. with the Boler School of Business at John Carroll University, says:

“The topic of active versus passive management is one that’s been extensively studied. It’s a testament to people’s faith that regardless of the research presented in favor of passive management, investors still put money into active management hoping someone can predict the market. Active managers can certainly find strategies to help them beat the market but generally not for very long (on average three-years). Financial markets don’t follow natural laws, like physics – the patterns don’t necessarly repeat. All aspects of finance employ a form of educated guessing.

As a result of our study, we caution investors to avoid actively managed funds. We recommend they invest in index funds or suggest that if they have a compelling reason for choosing active management, that they diversify among managers.”

What Does This Mean For Investors?  

Though active management is an appealing option to those looking to beat the market, research shows that active management has a hard time actually doing so and therefore investors should consider investing in passive funds instead. In addition, it’s important for investors to pay attention to the fund’s expense ratio to get a better sense of after-fee returns. For those looking to pick lower cost mutual funds and ETFs, NerdWallet’s Mutual Fund Screener helps investors find and compare over 15,000 mutual funds to find the best option. The tool also allows investors to filter funds using variables like the fund manager’s tenure duration and whether the fund is actively or passively managed.

 

NYSE photo courtesy of Rambleon / Shutterstock.com