Say a mutual fund makes a “best buy” list or is highly rated. Should you buy it?
The latest round of research, which confirms decades of academic findings, suggests you should avoid top-rated funds. They rarely repeat their best years.
According to a new study by Baird Wealth Management Research, not only do mutual fund ratings not predict future performance, they may be reliable red lights that should warn you against buying a fund.
Baird analyst Aaron Reynolds asked the question “do fund ratings predict future performance?” Here’s what he found:
* For US stock funds, the research found that ratings were negatively predictive of future performance, e.g. a high rated fund will perform worse than a low rated fund.
* For international stock funds, there did not appear to be a similar trend.
* For bond funds, ratings and performance showed a positive relationship and higher rated funds tended to show
higher performance.
How do you explain these results? Often, when a stock fund manager has a good year, it’s due to chance. Many funds reflect the market as a whole, that is, they are “closet” index funds that mimic the market at 10 times the cost.
If stocks in general have a good year, then most stock funds will do the same.  But having a good year should not be confused with persistence of performance. They probably won’t repeat their results.
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