The Best Predictor of Stock-Fund Performance
It appears to be as powerful as it is unknown.
In Good Company?
In 2005, three academics published a remarkable paper. "Judging Fund Managers by the Company They Keep", by Randolph Cohen, Joshua Coval, and Lubos Pastor, debuted a powerful method of forecasting the future performance of U.S. equity funds. When the authors sorted funds by the paper's new measure, the bucket that contained the lowest-decile funds recorded the single lowest average future alpha, the bucket with the second-lowest decile posted the second-lowest alpha, and so forth. With one minor exception, the pattern was unbroken.
(The authors' alpha calculations were based on the Carhart Four Factor Model, which adjusts for investment style. Using the Carhart model doesn't eliminate the possibility of an accidental finding, but it addresses the most obvious issues, such as the performance of small versus large companies or growth versus value stocks.)
John Rekenthaler has a position in the following securities mentioned above: BRK.B. Find out about Morningstar’s editorial policies.