How Long Can a Good Fund Underperform?
We give an in-depth look at how we determined that winning managers trail their benchmark for a decade on average.
The performance of an actively managed mutual fund is regularly compared against the performance of its benchmark to determine whether it is fulfilling its mandate to outperform that benchmark. While this seems like a straightforward exercise, it is complicated by the fact that a fund that ultimately outperforms its benchmark may go through a stretch of underperformance. For example, a fund that ultimately outperforms its benchmark over a 15-year period could have gone through an eight-year subperiod in which it underperformed. At the end of such a bad stretch, investors who evaluated the fund solely based on eight years of performance would have missed the subsequent outperformance.
The converse is also true. A fund that ultimately underperforms its benchmark over a 15-year period could very well have gone through an eight-year subperiod of outperformance, enticing performance-chasing investors to buy the fund, only to be disappointed by subsequent underperformance.