Rankings don’t equal returns
Investors need to know what strategy they’re buying
I’M OFTEN ASKED: How do you use fund rankings? It took me some research just to deal with the answer superficially. The answers are confusing or too touchy feely for my liking. Yet there are usually some hard facts behind rankings that also give some comfort. They may be a fine indicator of core competencies: but then again, you need to find out what delivered the performance that earned the rating. Bottom line is that you shouldn’t be buying or selling a fund on a ranking: it’s much more important to understand the investment strategy of the manager and its future prospects of success.
The first and obvious problem with rankings is they refer to past performance, which may or may not be a relevant indicator of future performance. Why? Well, after investing a few years on, fund managers and strategies sometimes change – and markets definitely change – improving or reducing returns. How much of what worked before is still valid? It’s not always easy to get clear answers, although a persistent adviser might be able to achieve the necessary.
The next question is how much of past returns were based on good, old fashioned index matching – and how much came from stock selection, allocation and timing? Yes, however loud the denials about the feasibility of market timing, the industry does it with a lot of success (and some miserable failures). They just label it selection or allocation – or may even call it “finding value or growth successfully”. A high risk-adjusted return ranking may indicate some consistency in those skills, because a typical ranking calculation usually covers a representative period such as three or five years. But a low ranking won’t necessarily indicate the opposite.
But the enquiry doesn’t end there. How did the strategy for the period covered by the ranking make the returns? Did the fund do best in a bullish or bearish phase of the market? Some funds thrive in volatility because they have the in-house skills to make returns from short-term moves. Other funds suffer.