Fidelity has a massive billboard up in Toronto to promote one of their portfolio managers, Will Danoff. Danoff has managed the U.S. based Fidelity Contrafund since 1990; it is the largest actively managed fund in the world managed by a single person. The Contrafund has performed well – well enough to beat its benchmark, the S&P 500. Benchmark beating performance attracts assets. It also gives Fidelity the opportunity to advertise to the world how great their star manager is. The problem for investors is that an active manager posting strong performance numbers, even over long periods of time, does nothing to indicate for how long that performance will persist.
Less than half of the equity mutual funds that existed in Canada a decade ago continue to exist today. If a fund has several years of poor performance, its assets will decline as investors move their money elsewhere. Eventually, the fund will close. If an investor is looking at the universe of mutual funds that are available to them at a point in time, they will only be seeing the funds that have done well enough to survive. Survival may be an indication of a truly skilled manager, but it could also be dumb luck. A 1997 peer reviewed paper by Mark Carhart titled On Persistence in Mutual Fund Performance looked at 1,892 U.S. mutual funds between 1962 and 1993. The conclusion of the paper was that there was no evidence in the data of skilled or informed mutual fund portfolio managers. In other words, good performance is most likely explained by luck.
Between survivorship bias and the lack of evidence of manager skill, it should be no surprise that many great fund managers have had dramatic falls from grace. The following examples are borrowed from Larry Swedroe’s The Incredible Shrinking Alpha.
In the 1970s, David Baker managed the 44 Wall Street fund to market beating performance for ten straight years. The following decade, it was the single worst performing fund, dropping significantly while the S&P 500 gained. Even more impressive was the Lindner Large Cap Fund, which beat the S&P 500 for the 11 years ending in 1984. While this market beating performance no doubt attracted attention, the fund spent the following 18 years being decimated by the S&P 500. If 11 years wasn’t enough to weed out the lucky managers, Bill Miller’s Legg Mason Value Trust Fund beat the S&P 500 for the 15 years ending in 2005. It suffered miserably against the index for the next seven years before being taken over by a new manager in 2012. Possibly most impressive of all is the Tiger Fund – a hedge fund formed in 1980. It spent 18 years averaging returns over 30% per year, and its assets had grown to a hefty $22 billion by 1998. Over the next two years the fund lost $10 billion, and closed its doors in 2000.
The odds of outperformance are slim, but some active managers do beat the market. The challenge for investors is identifying winning managers before they win. Unfortunately, finding a manager that has done well in the past is not helpful in finding a future winner.
Original post at pwlcapital.com