Introduction: The Siren Song of Performance
Each quarter, the financial media, including prestigious publications like Barron’s, publishes its list of the best performing mutual funds. These lists are magnetic. They tap into a deep-seated human desire to find winners, to be on the right side of the trend, and to believe that skill, not luck, drives market success. I have watched clients bring these lists into meetings, their eyes alight with the possibility of catching the next wave.
As a finance professional, my reaction to these lists is more measured, even skeptical. A list of top performers is not an investment strategy; it is a historical record, a snapshot of a race that has already been run. Today, I want to pull back the curtain on what these lists truly represent. We will explore the mechanics of how they are created, the profound dangers of using them as a buy list, and the far more valuable lessons they can teach an astute investor about risk, process, and the seductive trap of hindsight.
Table of Contents
Deconstructing the List: How “Best Performing” is Determined
First, it is crucial to understand that “best performing” is not an objective truth. It is a defined outcome based on specific, and often arbitrary, criteria set by the publication.
A typical Barron’s ranking might screen for the following:
- Time Period: This is the most critical and most misleading variable. Common periods are the previous quarter, year-to-date, trailing one year, trailing three years, or trailing five years. The shorter the time period, the more susceptible the list is to randomness and luck. A quarterly list is often little more than a list of funds that were most aggressively positioned for whatever theme was hot for 90 days.
- Category Classification: Funds are compared against their category peers, as defined by a classifier like Morningstar. A China Region fund is not compared to a US Large-Cap Value fund. This makes sense for the ranking but means the “best” fund might simply be the one that fell the least in a crashing sector.
- Asset Size and Liquidity: To avoid highlighting tiny, inaccessible funds, publications often set a minimum asset size, perhaps $100 million or more.
- Share Class: They may specify a particular share class (e.g., investor shares) to avoid duplication.
The output is a list, often sorted by total return for the period, declaring the “winners.” The inherent flaw is that this process is entirely backward-looking. It tells you what did work, not what will work.
The Perils of Performance Chasing: Why These Lists Are Dangerous
Using a “best performers” list as a buy menu is one of the most common and costly mistakes investors make. The strategy is intuitively appealing but financially destructive.
1. The Problem of Mean Reversion
In investing, what goes up often comes down, and vice versa. Funds that achieve top-quartile performance over a period are often those that took outsized risks or were concentrated in a specific sector that became overheated. The forces that propelled them to the top of the list—whether a speculative mania in tech stocks or a boom in emerging market debt—are rarely sustainable.
Academic research has consistently shown that top-performing funds over a 3-5 year period have a very low probability of remaining top performers in the subsequent 3-5 year period. They are far more likely to revert to the mean or even fall to the bottom of the rankings as the market cycle turns. By buying last year’s winner, you are often buying high, just before the inevitable correction.
2. The Ignorance of Risk
A list sorted solely by return is blind to risk. It does not answer the question: How did they achieve this return?
A fund could be at the top of the list because it:
- Used extreme leverage.
- Was concentrated in a handful of volatile stocks.
- Held illiquid assets that are priced infrequently.
- Simply got lucky.
The list celebrates the outcome but ignores the risk taken to achieve it. Two funds can have identical returns, but one might have achieved it with twice the volatility (standard deviation) of the other. The list will rank them equally, but they are not equal investments.
3. The Survivorship Bias Illusion
These lists only show you the funds that survived the period. They do not show you the funds that were liquidated or merged away due to poor performance. The universe of funds you see is already a curated winners’ circle, skewing your perception of the average manager’s skill. It’s like judging a war by only interviewing the survivors.
A More Useful Interpretation: What the List Can Actually Teach You
While I strongly advise against using these lists for stock picking, they are not without value. For a disciplined investor, they can serve as a diagnostic tool for the market’s recent health.
1. A Reading of Market Sentiment
The list of top performers tells you what market sectors or styles were in favor during the measurement period.
- If the list is dominated by Technology and Growth funds, you know the market was risk-on and favoring long-duration assets.
- If it’s filled with Value or Energy funds, you know the market was likely concerned about inflation or favoring deep-value plays.
- If Long-Term Treasury funds are on the list, you know there was likely a “flight to safety” and perhaps fears of an economic slowdown.
This doesn’t tell you what to do next, but it provides context for what has just happened.
2. A Showcase of Strategy (Not a Buy Signal)
You can use the list to identify funds with interesting strategies for further qualitative research. The fact that a fund appears on the list is not a reason to buy it. However, it might be a reason to investigate how it achieved its returns. Look beyond the number. Read the fund’s annual report. Understand its investment process, its portfolio concentration, and its manager’s commentary. The list can be a starting point for due diligence, not the conclusion of it.
3. A Reminder of the Need for Diversification
The sheer variability of the funds that appear on these lists from year to year is the strongest possible argument for diversification. One year it’s emerging markets, the next it’s small-cap value, the following it’s real estate. This churn demonstrates the impossibility of consistently predicting the top-performing asset class. Therefore, the prudent strategy is to own a piece of all of them through a diversified portfolio, ensuring you participate in the rallies while being protected from the full brunt of the downturns in any single area.
A Superior Framework: How to Evaluate a Fund Properly
Instead of chasing performance, I advise investors to build a portfolio based on a deliberate, forward-looking framework.
- Define Your Asset Allocation: First, decide your strategic mix of stocks, bonds, and other assets based on your goals, time horizon, and risk tolerance. This decision will drive 90% of your results.
- Select the Best Vehicles for Each Allocation: For each piece of your allocation, choose the most efficient fund. This is where you can consider both active and passive options. Your criteria should be:
- Low Cost (Expense Ratio): This is the most reliable predictor of future net performance. Prioritize funds with expense ratios in the lowest quartile of their category.
- Consistent Strategy: Does the fund stick to its stated mandate, or does it style-drift?
- Experienced Management: For active funds, has the management team been in place through multiple market cycles?
- Risk-Adjusted Returns: Look at metrics like the Sharpe Ratio or Sortino Ratio, which measure return per unit of risk taken, not just raw return.
Table: Performance Chasing vs. disciplined Investing
| Factor | Performance Chasing Approach | Disciplined Approach |
|---|---|---|
| Source of Ideas | “Best Performers” lists, recent headlines. | A strategic asset allocation plan. |
| Time Perspective | Backward-looking (what did well). | Forward-looking (what fits my plan). |
| Primary Metric | Trailing total return. | Expense ratio, tracking error, Sharpe ratio. |
| Result | Buying high, selling low; performance chasing. | Buying low, rebalancing; staying the course. |
| Likely Outcome | Underperformance due to poor timing. | Market-matching or better returns through cost control. |
Conclusion: Resist the Allure, Embrace the Process
The “Barron’s Best Performing Mutual Funds” list is a form of financial entertainment. It is designed to capture attention and sell magazines. It is not designed to be a viable investment strategy. The greatest bargain you will ever find is not a top-performing fund from a list; it is the freedom from the anxiety and underperformance that comes from chasing that list.
True investing success is profoundly boring. It is found in the unglamorous work of defining a plan, choosing low-cost, diversified vehicles to execute it, rebalancing periodically, and ignoring the siren songs of short-term outperformance. It requires accepting that you will never own the number one fund, and being perfectly content with that, because you understand that consistent, long-term wealth is built not by swinging for the fences on every pitch, but by simply being present for the entire game. Let the lists be a curiosity, a snapshot of history. But let your portfolio be a blueprint for your future.
