By Roné Swanepoel, Head of Sales at Morningstar South Africa

To quote the legendary Warren Buffett, “the investor of today does not profit from yesterday's growth”. As much as we have all heard the disclaimer on every investment advertisement that past performance should not be seen as an indication of future returns, many investors still switch to the latest hot offerings just before the inevitable slump in performance.

This year we have seen only 25% of stocks in the S&P 500 manage to outperform the index on a YTD basis, and the stocks driving the market (i.e. the Magnificent 7) now comprise close to 27% of the index. This is the most concentrated the market has been in 40 years. As these stocks have trended higher, investors have become more and more optimistic, and this is the exact moment that investors start buying more and more of these outperformers. Everyone loves a winner!

Investing is easy, right? Buy low, sell high. Walk away rich. Easier said than done, and I think most of us can admit we’ve had trouble abiding by this basic rule of investing in the past. Perhaps you bought GameStop stock in 2021 or pulled money out of investments during the early coronavirus market panic?

You’re not alone in feeling swayed by the ups and downs of the market, but these decisions can be costly. Performance-chasing—investing more in an asset when returns have been good and taking money out when returns have been bad—has been found to reduce the long-term returns an investor sees compared to those who did not chase returns.

The three/four-peat

Every six months, S&P Dow Jones releases a "persistence scorecard" that measures the consistency of active funds. According to the S&P Persistence Scorecard, relatively few funds can consistently stay at the top.

Let’s look at local market statistics, starting with the most successful ASISA SA General Equity funds. 25 funds landed in the top quartile of their peer group over the last 10 years ending June 30, 2024 (note, this only considers funds with a 10-year track record and excludes fund of funds).

Of these 25 funds, how many landed in their ASISA Category's top quartile three years or even four years in a row at some point during those 10 years?

As can be seen in the above graph, of the 25 funds (in the first quartile over 10 years) –

• Only ten funds managed to perform in the top quartile for three consecutive years over the 10-year period, and
• only 1 fund managed to achieve this twice over the ten years; and
• only four funds managed to achieve one instance of four consecutive first quartile performances over the ten years.

Some additional findings include:

• 20 of the 25 funds spent at least one year (of the 10 years) in the fourth quartile
• Every single fund spent at least one year (of the 10 years) in the third quartile
• 13 out of the 25 funds spent more than two years in the third quartile (over the 10-year period).
• These top-performing 25 funds (that managed to perform in the top quartile over 10 years) only spent 43% of their time (of the total instances over the 10 years) in the first quartile.

What can we conclude from these statistics? Performance chasing rarely works and it is more important to look at the consistency of a manager over the longer term.

The performance chaser

Morningstar conducted research into this area of investor returns and created a hypothetical ‘Performance Chaser’ portfolio. This portfolio tracks investors switching their investments into the best performing fund from the previous year at the start of each calendar year. This means that an investor sells the fund they are invested in every year, ranks all the funds in the category from best to worst over one year and switches their entire investment to the fund that has done the best over the last year. This is then compared to a portfolio managed by Morningstar – the Morningstar SA Multi-Asset High Equity portfolio (Morningstar Adventurous Portfolio).

The research aims to illustrate, through comparison, the returns achieved by the performance chasers versus the returns achieved by investors who remained invested in their respective portfolios over the same time frame.

As can be seen in the below graph, the difference in the return was quite astonishing.

The Morningstar high equity portfolio returned 36% (cumulative) more than the Performance Chaser portfolio over a period of more than thirteen years. In other words, an investor with an investment of R1 million that stayed the course (and remained invested in the Morningstar high equity portfolio) would have gained an extra R1 128 290 in returns over the thirteen year time period.

The above scenario clearly highlights the benefits of staying invested in a robust and consistent strategy as opposed to backtracking and chasing yesterday’s winners.

Let us examine the possible reasons for the underperformance of yesterday’s winners:

• The selected funds’ good ideas have all paid off and the returns have been realised.
• They may have had an aggressive view that played out in their favour. It’s unlikely that the view will continue for the foreseeable future and could potentially be at the top of the return cycle when an investor invests in the fund.
• This view could have been pure luck and not a solid investment thesis that the manager followed. For example, the fund could have been underweight offshore and then the rand strengthened due to a global risk on trade.

What does this mean for investors?

• Returns don’t happen in straight lines and it seldom occurs when one expects it to.
• The long term is just a collection of short runs and having a long-term strategy does not excuse you from the short-term setbacks in markets and funds.
• It’s vital to separate emotion from an investment portfolio. Often the most beleaguered investments turn out to be a great opportunity for future returns, as investors can access these investments at a good price.
• Volatility creates opportunity and short-term underperformance can translate into a solid, longer-term upside

Trying to chase performance can be extremely harmful to an investor’s returns over the long term. It’s rare (if not impossible), even for professionals, to consistently time investments in and out of the market over time. In addition, one needs to consider the costs of trading funds, which is likely to only make matters worse.

A well-diversified portfolio that is designed to meet your investment goals whilst remaining within your risk tolerance is a far better solution, and much likelier to result in long-term investment success than trying to buy yesterday's winners.

The Bottom line: investing is a marathon and not a sprint. When it comes to investing, patience is rewarded and time in the market remains superior to timing the market.