Mutual Fund Winners Don’t Stay Ahead for Long

That study, “On Persistence in Mutual Fund Performance,” by Mark Carhart, then a professor at the University of Southern California and now an asset manager, found that funds that rose in one year tended to rise in the next one, mainly because the stocks they held did the same thing.

Its findings seemed to defy the standard warning that “past performance doesn’t predict future returns” and prompted many people to scour past mutual fund returns in hope of scoring big future profits.

Well, don’t bother.

That’s the message of the new study by James Choi, a finance professor at Yale, and Kevin Zhao, a graduate student there. Their paper, “Did Mutual Fund Persistence Persist?” follows directly in the footsteps of Mr. Carhart, who studied mutual fund returns from 1962 to 1993. They examined what happened from 1994 until 2018, and found that the momentum effect in mutual fund performance that Mr. Carhart discerned is no longer apparent.

In an interview, Professor Choi told me that, like finance teachers around the world, he has been instructing students about the “momentum effect” in fund performance for years. One day, though, he had something of an epiphany.

“I was teaching a class about ‘the momentum effect’ and realized that I was basing everything I was saying on a study that was done more than 20 years ago, based largely on findings from 30 or more years ago,” he said. “I thought it was time to check and see whether it still worked.”

He and Mr. Zhao found that the strategy does not work in picking mutual funds; in fact, Professor Choi said, its effectiveness had diminished appreciably by about 1980, an apparent precursor of worse returns in subsequent years.

The research, available as a working paper, is to be published in the journal Critical Finance Review. Mr. Carhart, who reviewed it for the publication, called it “very solid. The efficacy of the momentum effect has declined over time. That’s in the data and I buy that.” He added that the strategy is no longer effective for picking mutual funds.

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