John Bogle's quote highlights that the past performance of money managers has no bearing on their future performance. In fact, every reputable study of mutual fund performance over the past 30 years has found there is no reliable way to know if past superior managers will win again in the future. This is why some variation of the disclaimer “past performance is no guarantee of future results” must appear in all mutual fund advertisements and prospectuses, even though the SEC allows it to be written in very small print.
Investment experts give several reasons why past performance is no guarantee of future results. The most frequently cited is that any outstanding track record turned in by a money manager is the result of the market favoring his particular investment style. One implication of this is that any such performance is entirely unpredictable—as is the time period that such good fortune may or may not last. Since market returns are correlated to risk factors (not to managers), there is no reason to expect that one manager will do better than another.
Despite the preponderance of studies that overwhelmingly reveal managers' inability to persist in performance, investors continue to succomb to the temptation to chase performance. Even more disturbing is the fact that insitutional investors such as governing boards of retirement plans, foundations and endowments frequently fall prey to manager-picking consultants and the allure of past winners. All too often, they impulsively hire the hottest new fund managers only to subsequently fire them because their past performance failed to persist.
A recent study conducted by Amit Goyal of Emory University and Sunil Wahal of Arizona State University found that manager hiring and firing decisions made by consultants and board members of retirement plans, endowments, and foundations was a complete waste of money and the board members precious time. "The Selection and Termination of Investment Management Firms by Plan Sponsors" reveals the negative impact of manager performance chasing. The results, as set forth in the figures below, demonstrate that during the ten-year period from 1994 through 2003, consultants and boards which based their fund manager hiring decisions on consistent above benchmark past performance were largely disappointed with subsequent index-like results. They often then fired their managers in favor of another recent top performer, repeating the cycle again. This cyclical motion undermines their investment policy statements and the opportunity of achieving optimal returns, the kind of returns that are available by simply buying, holding and rebalancing a passively managed portfolio of index funds that keeps costs low and controls risk.
