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The Fund Winner Curse Is an Optical Illusion

Just because winners decline doesn’t make them a bad choice

Good Is Bad 
A month ago, The Wall Street Journal ran a story called "Mutual Funds' Five-Star Curse." Morningstar featured (indirectly) in the headline, but the true subject was not the behavior of the star ratings. Rather, it was the inevitable disappointment that came from investing in the top-performing mutual funds. Whether measured by the Morningstar Rating for funds, or any other returns-based system, today's winners do not sustain.

Per the WSJ's report (which used Morningstar data), of funds that had the highest rating of 5 stars on July 2004, "37% had lost one star 10 years later. But 31% lost two stars, 14% dropped three, and 3% lost four [stars] … Only 58, or 14%, of the 403 funds that had five stars in July 2004 carried the same rating through July 2014, Morningstar says."

The reporters, and their editors, believed that this evidence demonstrated the fruitlessness of buying strong past performers. So, I suspect, did almost every reader. Those statistics arrive quickly, and they do look damning. A full 86% of all 5-star funds failed to retain their rating. And most of those fell by more than 1 star. Past performance, we are told, is a poor indicator of future performance. This study offers the evidence.

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About Author

John Rekenthaler, CFA  John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.

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