Morningstar Minute - Short term pain for long term gain

Almost all funds will underperform at some point, but it's important to step back and focus on the long term, says Michael Keaveney.

Michael Keaveney 11 August, 2017 | 5:00PM
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Michael Keaveney: Morningstar encourages investors to focus on the long term, but short-term performance reporting is everywhere, and there's a wide range of performance within a peer group.

For example, here are the best and worst returns among Canadian equity mutual funds over the last three calendar years. Now, these are literally the extremes, but with a range this wide, what would you do if you're not close to the best over the short term? We think it's important to take a step back, and think longer term.

We reviewed our Canadian mutual fund database for non-money market funds with a 10-year performance history from 2007 through the end of 2016. There were approximately 1200 distinct funds, and we looked more closely at those in the top 10% of their Morningstar category over the full period, by rating their individual calendar year performance.

This graph represents the number of calendar years where the funds with the top long term performance dipped under the category average performance. As you can see, virtually all of the top long term performers had at least one and often 2 or more calendar years where they were below the category average during their long run of top relative performance.

The flip side of the coin is that most funds with a poor long-term track record have spent at least some time basking in the glow of short-term outperformance versus peers. Looking at the lowest 10% of category performers over the same 10 year period, we see that most of them have at least one, and often two or more calendar years of above-average performance.

Don't be swayed too much by shorter-term relative investment performance in isolation. Certainly, if your fund does hit a patch of underperformance versus peers or the benchmark, then it is fair to make the effort to understand why, and determine whether the explanation makes sense, given your understanding of the fund's approach.

Conversely, don't be too impressed with a short-term performance surge to the head of the pack. It could end up being a brief blip in an otherwise poor track record. Differences in investment style mean that a manager's approach will almost inevitably fall in or out of favour over short periods.

We believe that a disciplined approach is important for long-term investment success, and part of that discipline is to be prepared, in advance, for bumps along the way.

For Morningstar Investment Management, I'm Michael Keaveney.

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About Author

Michael Keaveney

Michael Keaveney  Michael Keaveney, CFA, is Director, Investment Management at Morningstar Associates, Inc.

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