Understanding Fund Performance

Sunday 18 April 2004

Be careful when you look at a fund's track record. It doesn't mean you'll earn good future returns.

The events of the past year or two have reminded investors that the small print in managed fund advertisements is all too true: Past performance is no guarantee of future returns.

That poses a big problem for managed fund investors. After all, most of us begin our se

By The Landlord

arch for good funds by checking the fund's past records. Is that information really useless? If so, how should we go about choosing funds?

Answering those questions requires a clear understanding of why a fund's past performance might tell you little about its prospects.

Too much cash

For starters, some funds become victims of their own success. When a fund out-gains the market by a wide margin, investors quickly learn about its success, and pour their cash into the fund in hopes of sharing in its future gains.

That flood of cash can overwhelm even the strongest management team, who must find more shares to absorb all of it. The problem is especially troublesome for fund managers who buy small and medium capitalisation company shares. Adding too much cash to their favourite shares would quickly inflate the cost of the shares, and ultimately hurt the fund's performance.

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