12 March 2025
There is a saying in the world of cuisine, “the proof of the pudding is in the eating”. It is much the same in the world of manager research and fund selection, with superior long-term performance regarded as one of the, if not the most, important characteristics to measure. Evaluating funds using a 10-year compound annual growth rate (C.A.G.R. – smoothed average annual return over the 10-year period) ticks the box with a sufficiently long-enough evaluation period that spans across typical business, monetary and fiscal cycles. However, an often-under-appreciated feature of long-term returns is that they comprise many shorter-term periods. Looking at any sufficiently-long-enough time period return is useful, but far greater insight can be gained by analysing the intra-period returns, and how these short-term returns compound over the long-term.
Looking at how balanced funds performed over the past decade (2015 – 2024) provides us with useful lessons about what makes a fund successful over the long term. By comparing the last 10 calendar-year returns relative to the annualised 10-year return as of December 2024, we can identify trends among top and bottom quartile performers. Understanding these trends helps investors recognise the importance of consistency and downside protection as key features of manager skill and strategy, as well as the importance of staying the course in line with investment conviction.
Key Insights
- The top-quartile ranking funds over 10 years spent most of their time (68%) in the first and second quartiles.
- The bottom-quartile ranking funds spent most of their time (70%) in the third and fourth quartiles.
- More interestingly, bottom quartile funds over the 10-year period spent 16% of that time in the top quartile and 13% in the second quartile.
- The top funds had fewer and smaller losses compared to the worst performers. Bottom-quartile funds produced negative returns twice as often as top-quartile funds (26% versus 13%). Additionally, bottom-quartile funds on average, produced 60 bps greater negative returns (per year) when compared to top-quartile funds (-3.1% for top-quartile versus -3.7% for bottom-quartile). Avoiding big drops in value and negative returns helps money grow more effectively and steadily over time, which highlights the power of compounding. Taken together, this illustrates that top-quartile managers are more skilful at generating positive returns and managing downside risk.
- Even the best performing funds had some weaker years, spending 32% of the time in the third and fourth quartiles. However, when top performers found themselves in the bottom quartile in any single year, on average, 76% of the time they recovered above the median over the next 12 months, and 73% of the time they recovered and maintained above median performance over the next two years.
- Some funds have lumpy (inconsistent) return profiles – (which is not always a bad thing) however as investors we also need to understand the relationship between the return profile and investment strategy of the fund, so that emotions don’t take over when volatility does, and we remain committed to our investment strategy.
Balanced funds that perform well over the long term are not top quartile performers year-in and year-out and do show volatility in their return profiles. However, they are usually more consistent in the range of returns they produce and are meaningfully better at limiting negative returns. On the other hand, bottom-quartile funds can also shoot the lights out, but when they underperform, they are less adept at managing downside risk and are unable to recover to consistent peer-beating returns.
As with most things in life, the insight is in the detail. These analytical lenses are not the final word, but rather serve as a good starting point, from which to delve deeper into qualitative aspects such as asset manager philosophy, investment process, and investment experience and expertise.
