The study shows that only a tiny fraction of all funds have been able to consistently perform in the top 25% of all funds. As Craig notes, "this is no surprise for academics", i.e. markets are very efficient. But the authors of the study don't quite see it that way.
However, while these findings suggest that investors might be better off settling for the consistently average returns of index-tracker funds, Potter of TRMC says that would be a mistake. “This is not about changes in the quality of fund management,” he emphasises. “It’s a reflection of the fact there hasn’t been any consistency in the market itself.”Fund managers generally find it easier to outperform when the equity markets have followed a steady trend for some time. Potter notes that there were relatively high consistency ratios around 2003, after a downward market slide, and in 2007, towards the end of a long bull market.Actually, I'd argue that Mr. Potter is completely wrong here. It is entirely about the quality of fund management - and this is not to say fund managers are good or bad. The key issue is that investment markets are so efficient that if a manager does post three years of superior performance, it is more likely that this is due to luck rather than skill. The probability of being in the top 25% 3 years in a row is just (1/4)(1/4)(1/4)=1.5%. The fact that the study finds only 1.3% achieve this feat over the past 3 years seems entirely consistent with an efficiently operating market. Sure there are some time frames when a few more outperform, but again this is luck. For a summary of luck vs skill check out my earlier post.
So what is the average investor to do? One word: Index.