Sound Financial Group Blog

When is past performance not past performance? Investors need to understand how the performance tables of many fund sectors can be skewed to show improved returns.

The Financial Services Authority (FSA) has for many years now reminded investors that past performance is not a guide to future returns. There is also evidence from the academic world to support the notion that there is no proof to suggest that past performance persists (unless it’s poor performance). However performance tables for various asset class sectors are still produced to show those who appear to have out-performed their benchmarks over certain time periods and many investors will naturally want to follow these ‘winners’.
However, much of the past performance data is inaccurate in that it excludes those funds that have either been closed or merged with others. Funds that are closed are usually the poor performers that fund management firms decide are no longer a viable option and so this poor performance data is lost from the history. This results in what is known as a ‘survivorship bias’ among the remaining fund sector data.
Research from Vanguard suggests that in the 12 months leading up to a funds closure the average return of a UK equity fund was -3.58%.  Furthermore there will be costs for such closures and mergers in legal, consultancy, tax and management fees – much of this will of course be paid for by investors.
Figures from the Investment Management Association (IMA) suggest that over the last 12 years the investment funds industry has managed a 100% turnover of funds! Virtually a fund a day was closed and launched over this period. The research also reveals that around half of all funds over a five year period will have been merged or closed. How can any rational past performance decisions be made when such practices occur? The answer is of course that they cannot and should not.
The numbers emanating from past performance tables need to be taken with a very large dose of salt or better still ignored altogether.  
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