Good track record? Who cares!

Morningstar has updated it’s research on the factors that might help investors decide which investment funds to choose.  Once again they find that costs are the only reliable indicator of future fund performance.  The evidence is so clear in this area that they believe it should be among the top two criteria to use when screening funds.  We think this would naturally lead investors to prefer passive investment approaches (using ETFs and low cost index funds) but even among active funds, expense ratios are the best predictor of future returns.  And just to be clear, lower fees lead to better performance.  The chart below illustrates the percentage of funds by cost quintile that both survived and outperformed their category group between 2010 and 2015.

Morningstar fund costs

Despite the fact that cost is a better predictor than even Morningstar’s own star rating system, it isn’t the only thing to consider when picking an investment fund.  Funds need to be properly diversified and must have portfolio construction and management strategies supported by a strong theoretical foundation and empirical evidence.  Track record should be well down the list of criteria – past performance doesn’t tell us anything about future returns.

It should also be noted that the above research was conducted looking at US mutual fund data.  Mutual fund fees in Canada are nearly twice as high as they are in the US so the benefit of using costs to screen funds should be even greater here.