For the past 48 years, Forbes Magazine has annually published its Honor Roll – a “select list of time-tested, actively managed funds” that meet “demanding criteria”. This Honor Roll of recommended funds is expected – according to Forbes – to provide “meritorious after-tax performance over several market cycles.” Kiplinger Personal Finance Magazine has done something similar since 2004 – publishing the “Kiplinger 25” each year with its 25 favorite no-load mutual funds. Not to be left out, Money Magazine, annually produces its own list of the “Best Mutual Funds” – a “menu of high-quality funds that investors can use as building blocks in constructing a well-balanced portfolio.”
The intent is noble: provide individual investors with a selection of no-load, long-term-oriented, fee-conscious mutual funds for their portfolio. All three publications regularly highlight the importance of long-term investing. According to Kiplinger Personal Finance in the preface to their most recent Kiplinger 25 list: “We believe in holding funds rather than trading them, so we focus on promising mutual funds with solid long-term records.”
And while the intent of these recommended lists is honorable, they serve to reinforce the widely held and dramatically misleading concept that the past performance of actively managed mutual funds can provide useful prediction about future returns. To be clear- none of these publications select their recommended funds singularly by past performance. They each use different metrics including fees, consistency of strategy, and corporate culture but the choice of funds is distinctively driven by past performance. They all clearly cite historic performance as an important ingredient in their respective selection recipes. Furthermore, the removal of funds from these lists each year is generally decided by poor recent performance – further cementing the misleading value of historic performance. It is not a coincidence that the funds added to replace them – almost without exception – have strong recent performance at the time they are added. Such is the nature of these “best mutual fund” lists.
While these publications will often review the one-year performance of last year’s fund choices, there is no record that any of them ever review the longer-term performance of funds recommended several years ago. Or maybe they internally review the long-term results of their fund picks but recognize that publicizing the historic data would only serve to discredit their annual lists.
I thought it would be an interesting exercise to review the mutual fund picks from a decade ago and see how they did over the last ten years. Unfortunately, this exercise was more challenging than I anticipated. Possibly by design, nearly all of the decade-old mutual fund recommended lists have been expunged from the Internet.
Enter the magic of the Wayback Machine – a publicly available archive of nearly 500 billion web pages preserved over the past 25 years. Via the Wayback Machine and some crafty URL sleuthing, I was able to dig up several recommended lists from 2010. The findings and results from the 2010 lists are summarized below.
2010 Kiplinger 25 Best Mutual Funds
- Of the 10 actively managed US large company funds that Kiplinger included on its select list in 2010, just one (10%) outperformed the index over the last ten years.
- Of the 10 funds, one shut down halfway through the decade and three other recommended funds performed in the bottom 2% of all US large company funds over the past decade.
- Over the past decade, an equally weighted portfolio of the 9 recommended funds that still exist (excluding the fund that closed; rebalanced annually) delivered a cumulative return of 138%. This may sound reasonably good until considering that the passive Vanguard Large Cap ETF produced a 260% cumulative return over the same time period.
2010 Forbes Honor Roll
- Forbes named 10 mutual funds to its 2010 Honor Roll – a smattering of funds across different asset classes. Of the 9 actively managed funds on its recommended list, one closed down over the past decade due to unfavorable results.
- Only one of the nine recommended funds outperformed its benchmark over the past decade. In fact, over a decade in which the S&P 500 returned 14.1% per year, this was the only fund on the Forbes Honor Roll to achieve a double-digit annualized return.
- Unlike other lists, Forbes lists its funds in order of recommendation strength. The top fund in their list and the only A+ rated fund was CGM Focus. $10,000 invested in this top-rated fund on the list would have lost $179 over the past decade, declining to $9,821. That’s right – their highest rated fund lost money over a booming decade of growth. The same amount invested in the Vanguard Large Cap ETF over the 10-year period would have grown to $37,464.
- Assessing the 8 recommended active funds that lasted the full decade by a regression to determine whether they added or subtracted value (positive or negative “alpha”), only two of the eight funds added value (using the framework of a classic 3-factor Fama-French model).
2010 Money 70 Best Mutual Funds You Can Buy
- Of the 10 actively managed domestic large cap mutual funds recommended in the “2010 Investor’s Guide”, 90% trailed the S&P 500 over the past decade.
- Seven of the ten recommended funds lagged the S&P 500 by more than 2% per year over the past decade.
- An equally weighted portfolio of the 10 funds, rebalanced annually, trailed the Vanguard Large Cap ETF by 2.3% per year.
Lying is More Profitable than Telling the Truth
The findings of this exercise are telling but unsurprising. And while the preceding may discredit the utility of the recommended fund lists, this is not in any way meant to discredit the good work of these personal finance publications. Kiplinger, Forbes, and Money all do excellent work and consistently provide valuable personal finance advice.
Here’s the point: past performance makes for a great marketing gimmick but an atrocious determinant of future performance. If you ever find yourself choosing mutual funds based on past performance or from a “recommended funds list” that uses past performance as a meaningful ingredient of the selection criteria, consider throwing darts at a printed page of low cost funds as an alternative and far better process. The reason? It is really, really difficult to differentiate luck from skill. Many funds will look really good or really bad based on past performance purely by chance. And separating luck from skill generally requires a much longer time period than we want to believe – not five or ten years of good returns but 70 or 80 years. Robust studies such as this one, this one, and this one have all reached the same conclusions: that it’s nearly impossible to separate luck from skill in investment funds, that we repeatedly confuse luck with skill, and that the tiniest fraction of investment products actually exhibit any evidence of skill.
Morningstar – a company that made its fame and riches on the star rankings of mutual funds – has on several occasions debunked its original star-rating methodology that relied on past performance. The research actually suggests that investors would be better off buying funds with poor recent performance and selling funds with good recent performance. Such evidence provides further indictment about the utility of past performance as an indicator of future performance.
Sadly, the faith in hiring a team of human analysts, fund managers, or scouts to deliver a winning strategy is too deeply embedded to go away. Overconfident humans will forever search for the best mutual funds even if robust evidence highlights the folly of this exercise. Giving up on the quest would be an admission of failure. Personal finance publications will continue to provide “best mutual fund” lists because the public demands such – even if those recommended lists provide horrible long-term results. And the investment industry will likely never depart from the promotion of past performance because, regrettably, it is more profitable to lie to people who want to be lied to than to simply tell the truth.
No comment yet, add your voice below!