We are swiftly approaching the end of the year, a time for annual portfolio checkups by both investors and advisors. Undoubtedly, during this process, you’ll find a mix of investment products that are exceeding, meeting, or missing performance expectations. It is the disappointments that garner the greatest share of mental exercise.
A common first step in the monitoring process for many advisors is to set up a simple checklist that tracks whether or not a product is meeting certain quantitative performance criteria (i.e. three-month, one-year, three-year, five-year trailing returns, etc). If a product is trailing the benchmark over a market cycle (a three- to five-year period, generally), the question arises: Is it time to make a change? It depends…
As much as we here at Prima Capital would like to believe we would never pick a manager that would underperform over a market cycle, it happens. It is not uncommon for a manager that has established a successful long-term track record to have lengthy stretches of time when they trail their best-fit benchmark. For instance, according to research we recently performed, there have been an overwhelming majority of top 10-year performers that have had bouts of three-year underperformance.
Across eight different Morningstar open-end mutual fund categories, we filtered for funds that have a 10-year track record, a portfolio manager that has been at the helm for the entire 10 years, and for those that have outperformed their respective benchmark by at least 1% on a 10-year annualized basis. We then measured how many of those funds had a least one rolling 3-year period of underperformance (see table below).
Stemming from our experience assessing the performance of managers, we offer general guidelines plus more specific considerations when evaluating underperformers.