Question

Suppose you observe the investment performance of 350 portfolio managers for 5 years and rank them by investment returns during each year. After 5 years, you find that 11 of the funds have investment returns that place the fund in the top half of the sample in each and every year of your sample. Such consistency of performance indicates to you that these must be the funds whose managers are in fact skilled, and you invest your money in these funds. Is your conclusion warranted? (15 marks)

Answer 1

My conclusion is not completely warranted because there are a lot of economic cycles and mutual funds are performing according to their exposures in these economic cycle and it will not necessarily mean that these Mutual Funds have outperformed for a few years will always be outperforming the other mutual funds, and this can even under perform in coming years, so it can be concluded that past performance is not a guarantee for future performance because in stock markets, there is no guarantee for repetitive performance and if one is investing on the basis of the past performance, it is a type of investment bias that can lead him to serious trouble, so it can be said that one has to invest into the stock market after looking in four components of mutual funds rather than past performance of the mutual funds and he will have to do his own fundamental study and economic forecasting in order to analyse what kind of mutual fund, he wants to invest into a longer period of time and it is not completely dependent upon past performance because future expectation is what should be discounted rather than past performance.

There are certain economic cycle during which a lot of mutual funds are beating the rate of return of the market and this is because of their exposure into stocks, who have perform extraordinary well during the cycles but they have to be looked into for a longer perspective of time and one has to derive a forecast for economic cycles as well as company-specific cycle for a longer perspective because they can even top out when you are investing in them, and you will be stuck at top and your investment will not be returning anything for many years so one has to analyse various kinds of factors which would be macro factors as well as micro factors,before investment into a mutual fund and it will help them decide accordingly after discount in the future prospects of a mutual fund and the company and then one has to decide to invest into mutual fund for a longer prospective or not.

So, it can be concluded that my investment based upon the past return of these mutual fund managers are not warranted.