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Pick Funds for Process, Not Performance

October 28, 2013

Advisors endure endless pitches from fund companies touting their products’ recent performance. But the process they use to achieve returns is a much better measure of managers’ talent, according to Above the Market.

“Past performance is not indicative of future results” is a disclaimer funds slip into ad copy for good reason, the blog reminds us. As an example, Above the Market explains how one unnamed fund boasts of 9.93% average returns over the last 21 years, with a performance target 6% to 7% above inflation. It uses market timing to invest in cash, short-term bonds and uncorrelated high-yield debt.

This process is unlikely to continue outperforming, the blog argues. Sooner or later, central banks will reverse the long fall in short-term interest rates that triggered bond price rises. It is mathematically impossible for cash alone to return 6%-7% above inflation. This leaves junk bonds carrying the bag.

Junk bonds recently became positively correlated with Treasuries, according to Above the Market, perhaps because of fears over rising interest rates. That makes it difficult for them to continue performing like equities. So the fund is a non-starter, says the blog.

Yet fund managers routinely gain assets right after beating the market and lose assets soon after underperforming. What to do?

Turn to a sports analogy, of course.

The blog refers to legendary University of Alabama football coach Nick Saban’s method for winning national championships. Saban tells players to forget about winning or losing, but to adhere to the processes that lead to winning.

For fund managers, that means doing more than riding the wave of prevailing market conditions.

By Chris Latham
  • To read the Above the Market article cited in this story, click here.