By Tim Courtney, Chief Investment Officer
Several years ago a popular study of ours was featured in Barron’s – the study examined trends in performance and how these trends manifested within Morningstar’s “stars” for funds.1 Our findings looked at a 10 year period and concluded that funds which initially showed promising performance (receiving closer to five stars in the ranking) often failed to sustain this momentum over an extended period. In fact, only four out of 248 funds that carried five-star ratings from Morningstar in 1999 retained that status ten years later1, with many ceasing operations before the end of the decade. Over those ten years, lower ranked funds on average outperformed higher ranked funds
To be fair, Morningstar has since changed its methodology and they do provide some valuable research and analytical data. But predicting trends is difficult, and often the best performing strategy over one period can be one of the worst over the next. A similar observation can be made with a recent study we conducted on the popular ARKK Innovation ETF.2 Despite its positive inception performance of about 10% annually, the fund performed best when few dollars were invested and struggled the most after it became the largest actively managed ETF. The average dollar invested in the fund returned an astonishing -21% annualized since inception. While identifying a long-term trend early is rewarding, the uncertainty surrounding the duration of these trends can create risk if investors too heavily focus their portfolios.
A case in point is the recent economic shift in China. What seemed like an unstoppable upward trajectory was quickly reversed, plunging the country into economic challenges. Meanwhile, in the U.S, despite rising concerns over spending, the strength of the US dollar persists.3 When will this trend reverse? The timing of a tipping point is elusive – it could be near, or it might take decades. Another trend we’re seeing is in AI. Companies like Nvidia have experienced remarkable growth this year4, but the future trajectory of this trend remains uncertain. AI will be more utilized in the future, but we don’t know how it will play out or who the greatest beneficiaries will be.
In conclusion, this is the way the world works. There are trends that we can spot, but they could change quickly or persist for decades. We see this in sports teams too. Some teams build dynasties that last for years. Others have brief success when everything aligns perfectly but can’t repeat the success when chemistry changes the next year. While we should pay attention as information changes, we shouldn’t allow headlines to solely dictate our decision making. If you have any questions, please contact your Exencial Advisor.
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The internal rate of return (IRR) is a financial metric used to evaluate the potential profitability of an investment. It represents the discount rate at which the net present value of all expected future cash flows from the investment equals zero.