How Important Is a Fund's Performance History?
Many times it lends helpful context, but not always.
Question: I want to buy an index fund, but it looks like it’s brand-new and doesn’t have any performance history. Should I buy one that has a longer history to be safe?
Answer: I like where you’re going with this--it’s always a good idea to understand exactly what you’re investing in. When Morningstar analysts issue a rating on a fund, performance is one of many areas we analyze and consider.
That's why it feels heretical to write this, but in the case of a fund that tracks a broad-based, market-cap-weighted index, such as the S&P 500, an extensive performance history is less important. If you understand how the index is constructed and you understand how the fund replicates that index's return, usually what you see is what you get. These fund portfolios are constructed in a way that allows them to very closely match an index’s performance. For instance, S&P 500 funds often own all 500 securities in the same proportion as the index does.
One way these funds DO differentiate themselves is on cost, though. Fees are important because the return you get from an index fund is (very nearly) the index’s return minus the fund’s expense ratio. Broad-based, market-cap-weighted index funds usually have very low fees--often just a few basis points (or hundredths of a percent). For instance, if a fund’s expense ratio is 0.10%, you’ll pay $10 in fees on a $10,000 investment.
When Performance History DOES Matter
Having a meaningful performance history plays a larger role when you're evaluating an active strategy. Of course, past performance is no guarantee of future performance; that's why it's only one of many inputs that Morningstar analysts consider. Also, performance evaluation is usually more relevant if the team that earned the record is still running the fund.
By examining a fund’s performance relative to its process, you can determine whether the fund's managers have successfully achieved what they set out to do. Do they invest according to their stated philosophy, and has the strategy produced the expected results?
Even strategic-beta funds that seem like passive strategies fall into this category--when funds are weighted by some factor other than market cap, such as valuation or momentum, make sure you understand the process and how the fund behaves (or is expected to behave) in different market environments.
Let's look at an example: Vanguard Global Minimum Volatility (VMVFX), which has a Morningstar Analyst Rating of Silver.
The fund's prospectus explains that its main objective is "to provide long-term capital appreciation with lower volatility relative to the global equity market." To do that, it uses the FTSE Global All Cap Index as its starting point, but it will not track this index exactly because it also uses a screen to overweight stocks with low volatility and exclude high-volatility stocks from the portfolio. With that sort of process, you would expect the fund to have a defensive profile--to protect wealth better in down markets but not necessarily have stellar gains in strong market rallies.
Has it succeeded? Looking at the performance history since 2014 (when the fund was launched) bears out that it has been less volatile than the benchmark--its standard deviation of returns is 7.3 compared with 11.1 for the index. The performance profile is as you would expect, too: In 2017's strong rally, the fund racked up a more modest gain than the index. On the flip side, it managed to lose less in 2018.
Putting Performance in Context
At Morningstar, we consider performance as one piece of a mosaic, alongside a thorough evaluation of a fund's management team (if applicable), its process, and its price. We also consider whether the fund provider has a history of operating in shareholders' best interests.
Here's an excerpt from Vanguard Global Minimum Volatility's research report that shows how our analysts dive deep into a fund's performance when determining a fund's overall analysis and rating. Here, analyst Daniel Sotiroff explains that the Silver-rated fund has been less volatile than the index it tracks and, on a risk-adjusted basis, has outperformed that index. (You can read the full fund report (here).)
"This strategy has effectively dialed back on risk. The fund's standard deviation was 31% lower than the FTSE Global All Cap Index (USD hedged) between January 2014 and July 2018, allowing its risk-adjusted return to easily beat this benchmark. The fund's drawdowns averaged about 40% of its parent universe, which is consistent with strong risk-adjusted performance. Vanguard charges 0.17% annually for this fund, which ranks among the lowest expense ratios in the category, giving the fund a durable cost advantage."
Karen Wallace does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.