Past performance does not guarantee future performance.
You have seen this statement many times in mutual fund advertisements and in financial articles. Boy, was it true in 2000! The best funds in 1999 were mostly miserable performers in 2000.
Nevertheless, according to Sheldon Jacobs, editor of The No-Load Fund Investor newsletter "there is sufficient persistency of performance to make track records the primary means of fund selection."
For several years, I have followed the "Persistency of Performance" discipline suggested by The No-Load Fund Investor. The method is simple. Invest in the top-performing no-load diversified mutual fund of the previous year and hold that fund for 12 months. Repeat this procedure at the beginning of each year.
According to Jacobs, if you had followed this strategy for the past 25 years you would have done almost four times as well as investing in the average equity fund.
From 1975 to 2000, the strategy beat the average diversified fund in 16 of the 25 years, under performed in eight years and tied in one year. The strategy returned an average of 21.2 percent versus 15.1 percent for the average diversified fund.
However, since 1995 when the technology boom began, the top-performing diversified funds have, in reality, not been very diversified. Most of the top-performing (supposedly) diversified funds had more than 50 percent in technology.
Since 1995, the funds selected by Jacobs have under performed the average fund, returning only 13.9 percent per year versus 16.7 percent.
Statistics can tell you anything you want, depending on your parameters.
In 2000, the Jacobs selection, Van Wagoner Emerging Growth Fund, had a loss of 20.9 percent versus a loss of 3.5 percent for the average equity fund.
This column suggested two funds, Janus Special Situations and Marsico Focus.
They were both down about 17 percent in 2000.
However, Jacobs believes the problems of the past four years have disappeared because "the top funds in 2000 mostly had a value orientation," and he believes they will continue to perform above average this year. His pick for 2001 is the Clipper Focus Fund with a total return of 44.3 percent in 2000.
Many "value-oriented" funds did much better than the average equity fund in 2000, including Longleaf Partners Fund, up 20.6 percent for the year. My choices for continuing above-average performance in 2001 (besides Longleaf) are Meridian Value (up 37 percent in 2000), Berger Mid-cap Value (up 27.3 percent) and Weitz Value (up 19.6 percent).
I have stated before that this method is very risky, and I continue to believe that, if an investor is fascinated by this method, she should commit only a very small percentage of her assets in this manner. Jacobs agrees this is and always has been a risky strategy.
Mark Hulburt, editor of The Hulburt Financial Digest, strongly disagrees with any method that claims the top performers of one year are good bets for the next year. Hulburt says one-year track records are a horrible basis for picking an adviser or a mutual fund. "You would do better to flip a coin," he says.
Many financial advisers and writers will claim that long-term performance is the only way to judge future performance. Forbes magazine has a complicated procedure of rating funds on their performance through both bull markets and bear markets. Studies have shown that Forbes "honor role" funds rarely outperform the market over subsequent one-, three- and five-year periods.
Our confidence in a prudent asset allocation among many different asset classes is greatly reinforced by reading about these and other strategies.
Past performance cannot guarantee or predict future performance. It is only one factor to be considered when selecting a mutual fund for your portfolio.
Frank A. Jones, investment adviser and a former director of the Eighth District Federal Reserve Bank can be contacted at e-mail summit15@aol.com.