Past performance is better at spotting losers than winners

Ask most investors how they choose a fund and past performance comes near the top of the list. It's visible, it's comparable, and it feels like evidence of skill. New research from Morningstar covering 6,003 European funds suggests it isn't — but the more interesting finding runs in the opposite direction from the one you'd expect.

A Morningstar study examining 6,003 Europe-domiciled equity and fixed-income funds between 2010 and 2025 found that strong performance is hard to sustain. Funds that ranked in the top quintile — the best-performing 20 per cent — in any given year had just a 25 per cent chance of staying there the following year. Nearly as many, 24.6 per cent, either fell to the bottom quintile or disappeared entirely through merger or liquidation.

In other words, buying last year's top fund gave you roughly a one-in-four chance of picking a continued winner, and roughly a one-in-four chance of ending up with one of the worst funds in the category. That's not a signal. That's a coin toss.

What the bottom of the rankings tells us

The picture at the bottom is more instructive. Funds that ranked in the bottom quintile were far more likely to stay there or disappear than to recover: 34.9 per cent remained weak or were wound up, while only 17.8 per cent climbed to the top quintile. Poor recent performance, in other words, is stickier than strong recent performance.

This asymmetry matters. Past returns are a more reliable warning sign than a buy signal. If you're reviewing your fund holdings and one has spent a year near the bottom of its category, that's worth taking seriously. A year near the top? Less so.

Why does underperformance persist when outperformance doesn't? The study points to several factors. Smaller funds experiencing outflows are more likely to continue struggling. And in categories where low-cost passive alternatives are widely available, active funds find it harder to sustain any performance edge.

Some of the persistence that does exist among top performers isn't what it appears to be. Among equity funds, sustained outperformance is closely linked to momentum — the tendency of recent winners in the stock market to keep winning for a while. Funds tilted toward recent winners benefit when that trend continues, but face sharp headwinds when it reverses. What looks like manager skill can turn out to be a factor exposure that works until it doesn't.

The one signal that does hold up

If past performance is an unreliable guide, what should investors look at instead? The study is clear on one point: fees. Among low-cost funds, 25.9 per cent stayed in the top quintile from one year to the next, compared with just 18.1 per cent of expensive funds. At the bottom, the gap is even starker — 41.4 per cent of expensive funds remained there or were liquidated, against 29.2 per cent of cheap funds.

Fees matter for a simple mechanical reason. Every year, a fund's costs must be overcome before it can deliver a positive return relative to its benchmark. A fund charging 1.5 per cent annually faces that hurdle year after year. A fund charging 0.15 per cent faces a much smaller one. Over time, the arithmetic is unforgiving.

The past performance question worth asking

The practical implication is straightforward. When you're reviewing your portfolio or considering a new fund, the question to ask isn't 'which fund did best last year?' It's 'which funds have persistently high costs, weak processes, or a run of poor returns?' That's where the evidence says the signal actually lies.

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