Fun Fund Facts
When looking at investment funds (pooled or mutual) it is natural to want to keep the top performing funds and ditch the worst performers. But is this a good approach? To help answer this question, at least for Canadian equity funds, I had some fun with the funds’ facts on historical return rankings.
Fund Facts
I used the RBC Investor & Treasury Services’ Pooled Fund Survey[1] to obtain the return rankings of Canadian equity funds. RBC calculates a percentile ranking from 1 to 100 based on each fund’s return relative to the other funds in the survey. This is a common way for the industry to look at relative performance. The best funds are those in the top 10% (decile 1) or top 25% (quartile 1) of their peer group returns. The worst funds have returns in the bottom 10% (decile 10) or bottom 25% (quartile 4) of funds. When using quartiles, all the remaining funds are either in quartile 2 (above the median and below the bottom of quartile 1) or quartile 3 (below the median and above the top of quartile 4).
In each year-end Pooled Fund Survey over the years 2006 to 2022 there were anywhere from 110 to 130 funds. I eliminated a small number of funds to focus only on those that were actively managed and were not restricted to just small capitalization stocks.[2]
I looked at short and long time periods. For the short period I compared each fund’s calendar year-end return ranking to the following year-end ranking over the years 2009 to 2022. With the longer period I used the industry convention of trailing 4 year return rankings, which were available from 2006 to 2022. For each year-end I compared a fund’s trailing 4 year return ranking to their trailing 4 year ranking four years later.
Fun Facts – Short Periods
I started with the short period rankings. Each year every fund’s calendar year return ranking (time t) was compared to the next year’s ranking (time t+1). Chart 1 shows the percentage of time the top funds (quartile 1) and the bottom funds (quartile 4) funds were in quartile 1, 2, 3, or 4 the next year. For example, looking at the bars on the left side of the chart, over the years 2009-2022 funds ranked in quartile 1 at time t remained there 36% of the time the following year (t+1), 24% of the time they moved down to quartile 2, 16% of the time to quartile 3, and they fell to the bottom quartile 24% of the time. On the flip side, the bars on the right side of the chart show that bottom funds (quartile 4) stayed at the bottom 30% of the time.
Chart 1
Now let’s look at the calendar year rankings by decile in Chart 2. The top 10% of funds (decile 1) remained in quartile 1 the next year 42% of the time. The bottom funds (decile 10) remained bottom dwellers 33% of the time.
Chart 2
Fun Facts – Longer Periods
Next, I looked at the trailing 4 year rankings in Chart 3, which are better performance measures given the longer time period. The top funds (quartile 1) were roughly equally distributed among the four quartiles of trailing 4 year return rankings in the next year’s survey. On the other hand, the bottom funds (quartile 4) remained at the bottom 31% of the time. This was somewhat more than the percentage of time they moved up into the other quartiles.
Chart 3
Once again I looked at deciles in Chart 4. The top funds (decile 1) stayed in quartile 1 of trailing 4 year return rankings the next year 33% of the time, 20% of the time they moved down to quartile 2, 16% of the time to quartile 3, and 32% of the time to the bottom quartile. The bottom decile of funds remained in the bottom quartile 37% of the time.
Chart 4
Fun Facts Summary
There are a number of takeaways from the facts. First, for short periods (calendar year) it is somewhat more likely for top funds (especially top decile) to remain in the top quartile and bottom funds to remain in the bottom quartile. Second, for longer periods (trailing 4 years) top funds aren’t as likely to remain on top. Top quartile funds have about the same chance of being in any of the quartiles in the next 4 years, while top decile funds are about equally likely to be in either quartile 1 or all the way down in quartile 4. Third, over longer periods bottom quartile funds are somewhat more likely to remain in the bottom, with the odds even higher for bottom decile funds.
Fun Fund Implications
The facts show that over longer time periods there is more of a tendency for bottom funds to remain in the bottom quartile than for top funds to remain in the top quartile, and that using deciles to screen is better than using quartiles. But the percentages are not really high. These takeaways highlight the importance of evaluating the fund and its manager. For the evaluation you can use some of the “Top Ten Topics” I covered in Advisor Advice. A thorough analysis should uncover the factors that increase the likelihood that a fund will deliver better returns than its peers over the long run. Alternatively, the analysis may uncover red flags that point to continued poor performance.
Invest Wisely,
Dave Schaffner, CFA
Principal, Wayfairer Capital Management Ltd.
[1] Each quarter RBC Investor & Treasury Services’ Pooled Fund Survey compiles the pre-fee returns of over 90 asset managers (primarily Canadian) covering 700 high quality funds that are available to Canadian institutional (and in some cases retail) investors.
[2] The RBC survey results may be biased by managers reporting only on their good funds and ending their reporting on poor funds. In addition, over time some of the top performing funds were bought by other firms with funds in the sample. This may have resulted in changes to teams and processes which could have affected future returns. From the list of Canadian equity funds in 2009, only 30% were still in the 2022 survey.