Fund Authority Scores rate stock mutual funds and ETFs on the most important economic factors affecting long term diversified equity investment fund performance. This article explains how historical fund performance is calculated.
<<– Go to Part 1
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Part 1 of this article discussed direct and hidden investment costs, the most heavily weighted factors used in the Fund Authority Score rating system for stock – equity funds. These first two factors are: FACTOR 1: Annualized Investment Management Expenses and Sales Load Fees (-4 to +4 points) FACTOR 2: Hidden Trading Costs using Fund Portfolio Turnover as a Proxy (-3 to +3 points)
You can find a directory of Fund Authority Scores for mutual funds and ETFs here.
FACTOR 3: Penalize very inferior historical performance and credit average and superior historical performance (-2 to +2 points)
The scientific investment literature has demonstrated that previous superior or average fund performance simply does not predict similar superior or average fund performance in the future. However, there is good evidence that substantially inferior past fund performance is more likely to lead to continued inferior performance in the future. Much of this is sustained inferior performance is accounted for by the excessive costs of many funds with lousy past performance. Therefore, the Fund Authority Score rating system already has accounted for the influence of higher visible and hidden costs with Factor 1 (visible investment costs) and Factor 2 (hidden investment costs).
Millions of individual investors run futile hamster wheel races pursuing the illusion that the superior past performance of mutual funds and ETFs will lead to superior future performance. Without considering the far more important cost factors first, superior or average past fund performance will tell you very little or nothing about how a fund will perform in the future. You should, instead, pay close attention to the fine print in the prospectus that tells you that past performance does not indicate future performance and superior performance is not guaranteed and may not be sustained.
Simply ignore the investment fund industry’s selective marketing of only their past winners, while they sweep their losers under the carpet. (See these articles: Evaluate historical investment performance, but only after using other investment screening criteria, The illusion of superior professional investment manager performance, and How to lie with statistics: Investment performance charts)
The Fund Authority Score rating system gives a 20% weighting to historical stock [...]