Our widely followed SPIVA® Canada Scorecard repeatedly shows that most Canadian active managers underperform their benchmarks most of the time. However, if an active manager beats a benchmark, how do we know whether the result is a product of genuine skill or merely of good luck? Genuine skill is likely to persist, while luck is random and can soon dissipate.
The Persistence Scorecard attempts to distinguish luck from skill by measuring the consistency of active managers’ success. The inaugural Canada Persistence Scorecard shows that, regardless of asset class or style focus, few Canadian fund managers have consistently outperformed their peers.
For example, of the Canadian Equity funds that finished in the top quartile in terms of cumulative returns for the period from June 2010 to June 2015, only 8.3% finished in the top quartile for the period from June 2015 to June 2020. In fact, it was more likely for a top-quartile fund to close its doors or change style (25% combined) than to remain in the top quartile.
Even when using a less-restrictive metric for success, just 37.5% of Canadian Equity funds in the top half of the distribution for the period from June 2010 to June 2015 managed to repeat their top-half performance over the next five years.
This was hardly an outlier for any category or time period. Three-year transition matrices showed that in only one category (Global Equity) did more than 50% of funds repeat their top-half performance from the June 2014 to June 2017 period in the subsequent three years.
When looking at annual consistency, in five out of the seven categories tracked, none of the funds in their category’s top quartile in June 2016 maintained that status annually through June 2020. Over shorter time periods, no International Equity or U.S. Equity fund even managed to retain their top-quartile status for the next two years.
Some statistically minded readers might find support for the notion that fund performance is not randomly distributed. For example, the odds that a fund could remain in the top quartile for n consecutive years might be calculated as (25%)n = 25%, 6.25%, 1.56%, and 0.39% for one, two, three, and four years, respectively. While the persistence numbers in Reports 1 and 2 did intermittently top these thresholds, they remained quite low on an absolute basis. As such, while the Persistence Scorecard has not proven that fund performance is completely random, from a practical or decision-making perspective, it has reinforced the notion that choosing between active funds on the basis of previous outperformance can be a misguided strategy.
Unsurprisingly, the one pattern that did hold across categories was the tendency of the poorest funds to close. Calculating across all categories, there were 458 funds tracked over the period from June 2010 to June 2015. Observing their fates through June 2020, while just 8.6% of top-quartile funds ended up closing, 40.5% of funds in the bottom quartile did so. Seemingly coming in for the most opprobrium from their investors, 76.2% of bottom-quartile Canadian Focused Equity funds disappeared.
Style changes did not appear to be correlated with fund performance. Top, middle, and bottom performers within a category all generally had similar chances of style drift over the three- or five-year periods. Over the five-year period, Canadian Dividend & Income Equity funds had the highest percentage of style change (8.5%), with International Equity funds leading the way over the three-year period (5.4%).
