Active US equity managers, much like the rest of us, had a peculiar 2020.
There was no shortage of bad news for them, including US equity mutual funds being hit by outflows of $345bn (£253bn) in the first 11 months of the year.
But there was also a certain amount to be positive about, including the fact that 43% of these funds beat the S&P 500. Admittedly that percentage gets smaller when funds are benchmarked against style-specific indices, but let’s not focus on the negatives just yet.
And in among those outperformers were 15 mutual funds and three ETFs that delivered a return of over 100%, more than five times or more the S&P’s 18.4% rise.
According to a new paper by Morningstar’s Jeff Ptak, this is the highest number of funds to hit or surpass the 100% mark since 2009, when 19 funds achieved this. NB: 88 funds did it in 1999, a stat that pretty much gives away where the rest of this is going.
The 2020 numbers for those 18 funds are, of course, great news for investors who held them throughout the year. But as Ptak shows, those investors might not want to reward these managers by holding on for another 12 months, let alone three years.
As has been written before, persistent outperformance is a rare quality among funds and members of the 100 Club (as no one calls it) are no exception to this trend. Digging into 30 years of returns data, Ptak examined what has subsequently happened to such funds:
Of the 123 funds to have gained 100% or more in a calendar year since 1990, only 24 earned a positive return in the three years that followed. In other words, 80% of these funds went on to lose money. The average fund tumbled to a 9.9% loss in the year following its big gain, a 17.5% annual loss in the two subsequent years, and a 16.6% per year loss in the three years that followed.
So, what does this mean for 2020’s 100 Club? Are they doomed to suffer the same fate? While that is impossible to know at this stage, Ptak points out that ‘a strong predictor of how 100 Club funds fared in the years after their big gain was how they performed before that gain.’ He writes:
Funds that lost money before their big year saw an 11% cumulative loss in the years that followed the big gain, on average. By contrast, funds that made money before their big year lost 52% of their value in the ensuing three years. Thus, prior-year losses didn’t eliminate the possibility a fund would lose in the years after its big gain, but it made it less likely and the subsequent losses tended to be shallower.
All of which may not be great news for the class of 2020, with 17 of the 18 funds that gained 100% last year posting positive results for the previous three years, at an average of 23%.
The 18 funds are, unsurprisingly, a tight-knit bunch. Many have the same managers. Five are run by Morgan Stanley, two by ARK, two by Baillie Gifford, and three by Zevenbergen. All are firms that focus on US growth stocks, with a heavy emphasis on tech names.
As Ptak makes plain, it’s not a forgone conclusion these 18 funds will share the same fate as previous 100 Clubbers (yeah, I’m trying to make that a thing). But many of their holdings have been on strong runs and as a result look pricey, making the managers’ margin for error small.