THERE is nothing institutional investors dislike more than uncertainty since it robs them of their ability to plan for the future. This has led some institutional investors, in particular wealth managers and fund selectors, to exclude funds without a record of at least three years. The rationale is straightforward: looking at past performance allows investors to sift out the less successful funds and gives them some basis on which to project the fund’s returns. As BestInvest’s Adrian Lowcock stresses, you want to know that the manager you are investing in has a track record that is not just based on luck.
But while clear-cut, it may be misguided, according to new research from Lipper, the data provider. Lipper researchers Dunny Moonesawmy and Juan Manuel Vicente Casadevall say that excluding newly launched funds or funds with short track records might not be best. Having compared the performance of funds less than a year old and those with a track record for more than three years between June 2009 to June 2010, June 2008 to June 2009 and June 2007 to June 2008, they said: “We find no evidence that funds with long track records enjoy better performance or incur less risk than new funds.” The empirical data suggests that newly launched funds post higher average total returns and lower risk data. This means that institutional investors may miss out on several years of good performance if they exclude new funds from their portfolio.
But Crispin Lace, senior investment consultant at Mercer, says that the larger institutional investors such as sovereign wealth funds, pension funds and large charities do not necessarily screen based on number of years’ performance. Indeed, he points out that Mercer has worked with some fund managers to launch a new product.
In terms of manager performance, Moonesawmy and Casadevall found that “fund managers also tend to perform slightly better and they have a better chance to beat their peers at the beginning of their tenure”. While the research didn’t investigate this, it proposes that there might be two factors at play. First, a stellar first-year performance is virtually essential to generate significant money inflows, and by extension, continued success. Second, managers have strong incentives and pressure to outperform during the first couple of years of their fund’s existence.
But while a fund might outperform in its first year of life, there is no guarantee that it will continue to do so. Investors are still looking for active fund managers that can consistently deliver over a sustained period of time. There is no evidence yetto suggest that funds which enjoy a successful first year will necessarily become stars rather than dogs.