Experience Counts: Except When Selecting Mutual Funds

Who can quarrel with the value of experience? We want to be sure our doctors are well experienced in treating our illness, and we want to fly with pilots who have experience in the cockpit. Most people would prefer an experienced travel guide. When it comes to investments, surely more experience will likely mean higher returns. At least that's what many financial experts believe.

Here's one of many examples. In a blog post entitled "5 Ways to Find the Best Mutual Funds," Adam Bold notes the first "way" is to "check the manager's tenure and performance."

The view that longer tenure should correlate positively with higher performance is not surprising. Investors are always looking for ways to screen out funds that are likely to underperform and screen in funds that are likely to do the opposite. Unfortunately, what works well in other endeavors does not necessarily apply to investing.

At least this was the conclusion of two professors of finance, Gary E. Porter and Jack W. Trifts. They studied the impact of the tenure of mutual fund managers on performance, using a survivorship bias-free data set spanning 80 years, in order to identify the best actively managed fund managers with a tenure of 10 years or more. They examined the relationship between tenure and performance in a sample of 289 solo managers of 355 actively managed funds within the nine Morningstar styles. Here's a summary of their findings, which are quite surprising:

1. Managers with tenure of 10 or more years are likely to have significantly poorer performance the longer they manage. These managers were likely to have performed at or above market in the first three years of their tenure.

2. Fund managers who did not survive beyond three years significantly underperformed the market.

Professor Porter, in an interview, concluded: "As a result of our study, we caution investors to avoid actively managed funds. We recommend they invest in index funds or suggest that if they have a compelling reason for choosing active management, that they diversify among managers."

It seems that experience counts, except when choosing mutual fund managers.

Dan Solin is the director of investor advocacy for the BAM ALLIANCE and a wealth adviser with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His next book, The Smartest Sales Book You'll Ever Read, will be published March 3, 2014.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.