Mutual fund past performance data can be misleading
March 26, 2022
There is a bias in mutual fund past performance than can overstate past results, writes Peter Watson.
Since mutual funds are the investment vehicle of choice for most Canadians, it is helpful to understand how to interpret information that is publicly available.
We will follow the path of a very astute investor who wants to invest in a US equity mutual funds. Initially they look at past performance for all funds in the US equity category, then just the funds of one specific fund management firm.
Does this appear to be very thorough research? Yes, absolutely it does.
Is this publicly available information that was used in the investor research reliable? No, surprisingly unreliable.
The reason is the data is incomplete. According to Morningstar Direct, starting in January 1991, about five per cent of mutual funds are eliminated every year. And instantly, their past performance results disappear.
Funds that disappear are more likely to have disappointing results than the funds that remain. Think of how your academic success could have been improved if you could have done this back in your school days.
Write an examination with 10 questions. Then review the marks for each question. Pick out your five worst marks and eliminate them. Presto, you are now and “A” student.
Because the astute investor was looking at misleading past performance data, they will have overestimated the ability of all the US equity managers plus likely overestimate the past performance the specific management firm they reviewed.
We recommend you consider the potential overstatement of managers past performance record.
Peter Watson is registered with Aligned Capital Partners Inc. (ACPI) to provide investment advice. Investment products are provided by ACPI. ACPI is a member of the Investment Industry Regulatory Organization of Canada. The opinions expressed are those of the author and not necessarily those of ACPI. Watson provides wealth management services through Watson Investments. He can be reached at www.watsoninvestments.com
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