Funds with Legs for the Long Run

A Standard & Poor's Persistence Scorecard highlights mutual funds that steadily beat their peers over the past five years

by Jane Sandiford

Past performance may not be a guarantee of future results, but it can help identify some worthy mutual funds. The semiannual S&P Mutual Fund Performance Persistence Scorecard tracks the consistency of top performers over consecutive three- and five-year periods. The survey uses "apples to apples" comparisons, so large-cap funds vie with other large-caps, not with mid- or small-cap portfolios.

Very few funds manage to repeat top-half or top-quartile performance. Only 71 (or 13.2% of) large-cap funds, 16 (9.9%) mid-cap funds, and 24 (10%) small-cap funds maintained a top-half ranking over five consecutive 12-month periods ended December 31, 2006. Only eight (3%) large-cap funds, two (2.5%) mid-cap funds, and no small-cap funds maintained a top-quartile ranking over the same period.

"This research suggests that screening for top-quartile funds may be inappropriate as the sole basis for an investment decision," says Srikant Dash, index strategist at S&P. "A majority of top-quartile funds in the future come from the ranks of prior-period second- and third-quartile performers, and the absolute counts of repeat top performers are low."

What distinguishes the top performers from the rest? We found that, in general, consistently strong funds have lower expense ratios than their peers and managers who have been at the helm longer. Not unsurprisingly, bottom-quartile funds were much more likely than top-quartile funds to be liquidated or merged into other portfolios.