Continue with our Morningstar experts‘ opinions on “how to use fund performance data”. You can read the first part of the article here.
Sam Lee, ETF strategist and editor of Morningstar ETFInvestor
Past performance is by itself a mostly useless and potentially harmful measure by which to judge a strategy. First, it's sensitive to the start and end dates at which you look. Second, the periods during which performance data are available are often too small to be meaningful. A strategy with a great three- or five- or even 10-year record is likely not going to continue to outperform in a meaningful way (otherwise picking a winning strategy and making lots of money would be easy). If you're going by performance alone, you often need decades of performance data to come to a statistically meaningful conclusion, and that's assuming the process generating those returns doesn't fundamentally change. Finally, strong historical performance in an asset class or strategy often suggests the asset is expensive or the strategy is crowded and should therefore be avoided.
The real value in using past returnsis to supplement, not dominate, a holistic assessment of a strategy or asset because a good strategy or asset can experience years of bad returns, and a bad one can experience years of good returns. Past performance rarely provides enough information to strongly affirm or disconfirm a strategy's merits. When it does, it's usually to disconfirm. (Poorly performing active managers tend to experience persistent underperformance.)
For these reasons, I tend to focus my energy on identifying strategies with strong economic intuition behind them, confirmed by multiple independent researchers as having worked during many decades and in many different countries.
Eric Jacobson, senior fund analyst
On the bond side, we tend to look a lot at specific time periods that characterize particular market events. For example, the third quarter of 2011 was especially bad for riskier assets and an excellent time to hold Treasuries. (2008 looked a lot like 2011's third quarter, only much worse.) How well or poorly a fund performed in a specific period often says something about how much risk it was taking at that time, whether its duration [a measure of interest-rate sensitivity] was particularly long or short, and so on. More recently we've been looking at the May/June 2013 period. Interest-rate sensitivity, Treasury Inflation-Protected Securities, and emerging-markets bonds were all negatives during that stretch. Calendar-year returns can be useful in this context also.
Other than that, we often try to look at a fund's record during the time its manager has been in charge. The virtue of that number is simply that it doesn't introduce overlapping time periods. I look at trailing returns a bit more carefully and in a more nuanced way because of the fact that they overlap so much (that is, the three-year return is also represented in the five-year number, and each can change quickly if a particularly strong or weak period rolls off, for example).
Michael Herbst, director of active funds research
As an analyst, I look at performance from a number of angles. For instance, I’ll look at absolute, relative, and risk-adjusted performance during a fund manager's tenure to see how the fund has fared versus its benchmark, investable passive offerings, and actively managed rivals. I'll also look at those measures during trailing periods, typically emphasizing the five- and 10-year periods; one thing to remember there is a fund's historical performance can look much different once key events, such as 2008's crisis, roll off the record. Across those time periods I'll look at downside capture to get a better sense of how defensively a manager has run the fund because it can be painful to recover from losses. I look at those other metrics to determine how successful a manager or fund has been at executing its strategy, and to get a better sense of what investors can reasonably expect going forward. That's because a big risk of any fund is the one staring back at you in the mirror--if I know when a fund should shine or when it might crater, I'm less apt to buy or sell it at the wrong times.
In my own investing, before I even get to performance I assess the stability of a fund's management, the stewardship of the firm backing the fund, and expenses. Ultimately I can't control performance; what I can control is limiting the risks related to manager turnover, poor stewardship, and high expenses. If I can get comfortable in those areas, then I'll look at performance from the angles described above to decide for myself where a fund will fit in my portfolio, when it would make sense to take gains, and when I should plan to have money available to buy additional shares after a fund takes a big hit.
Dan Culloton, associate director of fund analysis
I look at performance last, or at least try to, because as we all know, it's no guarantee of future results. I usually default to the longest possible period, whether that be the start of the tenure of the lead or longest-serving manager or the inception of the fund. Within that time frame I'll look at cumulative, annualized, calendar, quarterly, rolling, and specific time periods to see how a fund has behaved during various time spans. Within those time frameworks I'll often look at absolute returns and the fund's returns verse sits prospectus benchmark, category peers, and other peer groups, indexes, and rivals that I think might be relevant. Risk-adjusted returns--Morningstar measures and Sharpe, Sortino, and information ratios--are helpful, as are simple measures such as standard deviation and upside/downside capture ratios.
All this is just noise, though, if you don't connect it to what you know about the process and portfolio. Is the performance consistent with what you would expect from this approach and these holdings? What do the holdings and the historical track record say about future risks or prospects? What should investors expect?
Adam Zoll is an assistant site editor with Morningstar.com
