The Never-Ending Failure to Identify Future Mutual Fund Outperformers

Countless investment practitioners and academics have unsuccessfully searched for the metric that can successfully identify future mutual fund outperformers. What follows is the saga of the latest failed attempt.

Recently, the search for outperformance has focused on the theme that superior stock selection ability is positively associated with the distinctiveness (referred to as “active share”) of a fund’s investment decisions – with distinctiveness based on either a fund’s portfolio holdings or the fund’s returns.

My February 21, 2022, Advisor Perspectives article examined the evidence from empirical research on the ability of active share to predict future performance of actively managed mutual funds. For example, in its November 2021 study, “Is Active Share Unattractive?,” Morningstar found that despite exhibiting greater risk, high-active-share funds failed to deliver superior net-of-fees results in any category. Despite that, active share has become an increasingly popular metric in terms of both reporting and evaluation. Given the evidence, there isn’t a logical explanation for that phenomenon other than that high active share is a necessary ingredient for outperformance.

Unfortunately, it’s not a sufficient one.