Content provided by Rui Wang, CLS Research/Portfolio Analyst

Fund investors tend to chase top performers and abandon bottom ones. According to recent research done at CLS, this strategy is myopic and does not serve an investor’s best interest in the long term.

Using Morningstar’s mutual fund database, we collected three years of rolling category return rank data for each mutual fund dating back to 2001. The idea was to test how the funds’ past relative performance within their Morningstar assigned categories impacted their future relative performance. In other words, we tried to test whether a fund with a high past category return rank could maintain its top status, and if a fund with a low past category return rank stayed at a low rank three years later.

The charts below summarize our findings. On average, less than a third of top performing funds can keep their high rank while about a fifth of them will perform poorly among their Morningstar peers in three years. On the contrary, only less than one-fifth of bottom funds still perform poorly during the next three years while nearly 60 percent of them will outperform the category average. It is surprising to see that according to our research, nearly 40 percent of bottom funds will become top funds during the next three years.

Our research illustrates how obvious it is that funds in the top 25 percent struggle to maintain their top status while most funds in the bottom 25 percent outperform the category average in the next three years. It is unlikely that any strategy will outperform the market since it evolves over time. By the same token, CLS’s research indicates that previous dogs can become stars when the market climate shifts. Rather than chasing the performance, I believe it is in the best interest of a long-term investor to be patient with their current fund strategy, and manage the risk prudently.

This information is prepared for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. You should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. You should note that security values may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not a guide to future performance.

1605-CLS-08/01/2013