Past performance is no guarantee of future results.
Those are the words found on every U.S. mutual fund and ETF prospectus, and they are the primary reason investors should not blindly chase performance.
This year is a primary example. According to Todd Rosenbluth, director of ETF and Mutual Fund Research, CFRA (which recently acquired the equity and fund research business of S&P), the equity funds that prevailed in the first half of 2016, namely, defensive income-oriented sectors of the S&P 500, have lagged in the second half, where more economically sensitive sectors have been leading the market higher.
Investors who had favored funds focusing on dividend-paying sectors such as telecom and utilities which gained more than 20% in the first half, saw those sectors forfeit more than half those gains during the second half of the year through October 14. Leading the market now instead is technology, which is up 10.4% year-to-date.
Ideally, actively managed funds, unlike indexes – especially sector indexes – have the flexibility to capitalize on market changes, rotating out of an overweight position in one sector or stock into another, but according to CFRA's MarketScope Advisor platform, only 22% of actively managed large-cap funds have beaten the S&P 500 since 2007 and the pattern is holding this year as well.
Rosenbluth recommends that advisors focusing on the top-performing fund at any one period of time understand why the fund has outperformed, knowing whether it tends to skew more defensive, which often lags during cyclical times but does well in chopper times, or skews more aggressive, when the opposite is true.
Advisors also need to understand how a fund has changed its portfolio over time, says Rosenbluth. "If active management is doing great they're shifting exposures and rotating in and out of sectors."
For example, Fidelity Strategic Dividend & Income Fund (FSDIX), which gained 8.5% through the first half, is up 9.1% through October 14. It was underweight consumer staples and had a market weighting for utilities relative to the S&P 500 at the end of August, which helped performance in the third quarter.
