Investments, tenth edition

 Figure 4.4 

Rates of return on actively managed equity funds versus Wilshire 5000 index, 1971–2011   

Source: For Wilshire returns, see www.wilshire.com. Used with permission of Wilshire Associates. For active fund returns, see http://

www.fiscalisadvisory.com/assets/pdfs/spiva_report_year_end_2011.pdf .

240

230

220

210

0

10

20

30

40

R

a

te

 of

 Re

tur

n

 (%)

Active Funds

Wilshire 5000

1971

1975

1979

1983

1987

1991

1995

1999

2003

2007

2011

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  C H A P T E R  

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  Mutual Funds and Other Investment Companies 

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  Table 4.4  presents such an analysis from a study by Malkiel.  

6

   The table shows the frac-

tion of “winners” (i.e., top-half performers) in each year that turn out to be winners or los-

ers in the following year. If performance were purely random from one period to the next, 

there would be entries of 50% in each cell of the table, as top- or bottom-half performers 

would be equally likely to perform in either the top or bottom half of the sample in the 

following period. On the other hand, if performance were due entirely to skill, with no 

randomness, we would expect to see entries of 100% on the diagonals and entries of 0% on 

the off-diagonals: Top-half performers would all remain in the top half while bottom-half 

performers similarly would all remain in the bottom half. In fact, the table shows that 65.1% of 

initial top-half performers fall in the top half of the sample in the following period, while 64.5% 

of initial bottom-half performers fall in the bottom half in the following period. This evidence 

is consistent with the notion that at least part of a fund’s performance is a function of skill as 

opposed to luck, so that relative performance tends to persist from one period to the next.  

7

    

 

On the other hand, this relationship does not seem stable across different sample 

periods. While initial-year performance predicts subsequent-year performance in the 1970s 

(panel A), the pattern of persistence in performance virtually disappears in the 1980s (panel B). 

To summarize, the evidence that performance is consistent from one period to the next is 

suggestive, but it is inconclusive. 

 Other studies suggest that there is little performance persistence among professional 

managers, and if anything, bad performance is more likely to persist than good perfor-

mance.  

8

   This makes some sense: It is easy to identify fund characteristics that will result in 

consistently poor investment performance, notably high expense ratios, and high turnover 

ratios with associated trading costs. It is far harder to identify the secrets of successful 

stock picking. (If it were easy, we would all be rich!) Thus the consistency we do observe 

in fund performance may be due in large part to the poor performers. This suggests that 

the real value of past performance data is to avoid truly poor funds, even if identifying the 

future top performers is still a daunting task.