Persistence

What Is Persistence?

Persistence, in the context of investment performance analysis, refers to the tendency of an investment's returns to continue a specific pattern over time. For example, if a mutual fund consistently outperforms its benchmark in one period, persistence would suggest it has a higher likelihood of continuing to outperform in subsequent periods. This concept is central to evaluating investment strategy and understanding the factors that drive sustained portfolio performance. While investors often seek persistence as an indicator of manager skill, academic research has extensively debated its actual presence and underlying causes, particularly in the realm of active management.

History and Origin

The debate surrounding investment performance persistence gained significant traction with the advent of modern portfolio theory. A seminal paper in this area is "On Persistence in Mutual Fund Performance," published in 1997 by Mark M. Carhart. Carhart's research, using a sample free of survivorship bias, indicated that common factors in stock returns and investment expenses largely explained observed persistence in equity mutual funds' mean and risk-adjusted return⁴⁸, ⁴⁹, ⁵⁰. He notably concluded that the results did not strongly support the existence of skilled mutual fund managers capable of persistent outperformance due to superior stock-picking. Instead, the "hot hands" phenomenon, where top-performing funds seemed to continue their success, was largely attributed to the momentum effect in stocks, as well as persistent differences in fund expense ratio and transaction costs⁴⁴, ⁴⁵, ⁴⁶, ⁴⁷.

Key Takeaways

• Short-Term vs. Long-Term: While some studies show evidence of short-term persistence, especially over one-year periods, this tendency largely diminishes or disappears over longer horizons⁴⁰, ⁴¹, ⁴², ⁴³.
• Skill vs. Factors: Much of the observed persistence can often be attributed to market factors, investment styles, or cost structures rather than inherent manager skill³⁶, ³⁷, ³⁸, ³⁹.
• Regulatory Disclaimers: Investment advertisements typically include mandatory disclaimers stating that past performance is not indicative of future results, reflecting the lack of reliable long-term persistence³⁵.
• Underperformance Persistence: Interestingly, poor performance often shows more persistence than good performance, meaning funds that perform badly are more likely to continue doing so³³, ³⁴.

Interpreting Persistence

Interpreting persistence in investment returns involves analyzing whether a fund or manager's historical portfolio performance consistently places them in a particular ranking quartile over successive periods. For instance, studies might track what percentage of top-quartile funds remain in the top quartile over the next one, three, or five years. If a significant percentage consistently remain at the top (or bottom), it suggests persistence. However, even if statistical evidence of persistence is found, it does not automatically imply that investors can profit from it, as transaction costs or other market dynamics might erode potential gains³². Furthermore, persistence research often attempts to discern if observed outperformance is due to true alpha—excess returns beyond what market risk factors like beta explain—or merely random chance.

Hypothetical Example

Consider an investor, Sarah, who is reviewing two actively managed mutual funds, Fund X and Fund Y, for her portfolio. Fund X has been a top performer for the past two years, consistently ranking in the first quartile of its peer group. Fund Y has had average performance over the same period. Based purely on recent history, Fund X appears to be the more attractive investment strategy.

However, if Sarah applies the insights from persistence research, she would understand that Fund X's strong past performance does not guarantee its future success. While it might show short-term persistence, studies suggest that few funds consistently maintain top-quartile performance over longer periods. For example, an S&P Dow Jones Indices study found that only 8% of domestic equity funds that were in the top quartile remained there over a subsequent three-year period. Th³⁰, ³¹erefore, Sarah would recognize that simply chasing past returns could lead to disappointing future results in her portfolio management.

Practical Applications

The concept of persistence has several practical implications for investors, regulators, and the financial industry:

• Regulatory Requirements: The U.S. Securities and Exchange Commission (SEC) mandates that investment advisers include prominent disclaimers in their advertisements, such as "past performance is not indicative of future results". Th²⁹is is codified under the SEC's marketing rule, which requires specific disclosures regarding performance presentations, including minimum one, five, and ten-year periods, to prevent misleading investors by implying guaranteed future returns based on historical data. Th²⁵, ²⁶, ²⁷, ²⁸is rule aims to protect investors from making decisions based solely on potentially misleading historical returns.
• ²⁴ Investor Behavior: Despite regulatory warnings, many investors exhibit "performance chasing," gravitating towards funds with strong recent returns, hoping the trend will continue. Understanding the limited nature of persistence can help investors adopt more disciplined investment strategy and avoid common behavioral biases.
• Fund Selection: Instead of relying heavily on past performance as the primary criterion, investors can focus on other characteristics, such as the fund's expense ratio, its alignment with their investment objectives, and its role in overall diversification and active management approaches.

Limitations and Criticisms

A significant limitation of performance persistence is its general lack of robustness over longer time horizons. The Efficient Market Hypothesis posits that asset prices fully reflect all available information, making it difficult for any manager to consistently generate alpha beyond what is explained by risk. Empirical studies, such as the S&P Persistence Scorecard, consistently demonstrate that very few funds maintain top performance over multi-year periods. Fo¹⁹, ²⁰, ²¹, ²², ²³r instance, a report tracking top-performing funds in September 2017 found that only 47% maintained their top-quartile performance a year later, plunging to just 8% over a three-year period.

C¹⁷, ¹⁸ritics also point out that perceived persistence might be an artifact of statistical methodology, such as survivorship bias, which occurs when poorly performing funds that are closed or merged are excluded from historical datasets, artificially inflating average returns and creating an illusion of persistence. Fu¹⁶rthermore, factors like momentum or exposure to specific factor investing strategies can explain short-term outperformance, rather than genuine, repeatable manager skill.

#¹², ¹³, ¹⁴, ¹⁵# Persistence vs. Luck

The distinction between persistence and luck is fundamental in investment analysis. Persistence implies a repeatable, systematic ability to generate strong returns, suggesting underlying skill in portfolio management or a consistent advantage derived from an investment strategy. Conversely, luck refers to random chance, where superior or inferior performance occurs without a consistent, attributable cause.

While investors often seek persistence as a signal of manager skill, academic research predominantly suggests that much of the observed performance "persistence" is largely attributable to factors like market momentum, differences in expense ratio, or simply random chance (luck), rather than a consistent ability of managers to beat the market or generate alpha. Th⁸, ⁹, ¹⁰, ¹¹is view aligns with variations of the Efficient Market Hypothesis, which implies that sustained outperformance, especially after accounting for risk, is exceedingly rare. Studies using models like the Capital Asset Pricing Model (CAPM) and its extensions often find that once various risk factors are controlled for, true persistence related to manager skill is minimal or non-existent.

#⁵, ⁶, ⁷# FAQs

Q1: What does "persistence" mean in investing?

Persistence, in investing, refers to the tendency for an investment's performance, particularly that of mutual funds or managers using active management, to continue in the same direction (e.g., outperforming or underperforming) from one period to the next.

Q2: Does past performance guarantee future results?

No, past performance does not guarantee future results. This is a mandatory disclaimer in investment advertising in many jurisdictions, including the U.S. where the SEC requires it. Re⁴search consistently shows that while some short-term patterns might exist, sustained long-term outperformance is rare, making past results an unreliable predictor for future portfolio management success.

Q3: What factors can make performance appear persistent?

Factors such as market momentum, differences in fund expense ratio and transaction costs, and exposure to certain market characteristics (as studied in factor investing) can contribute to the appearance of persistence in returns, often more so than individual manager skill.

#¹, ², ³## Q4: How should investors use information about performance persistence?

Instead of relying on past performance, investors should focus on developing a sound investment strategy that emphasizes principles like diversification, managing expense ratio, and aligning investments with their long-term financial goals and risk tolerance. Research on persistence suggests that attempting to pick future winners based on past returns is often an unsuccessful approach.