Lipper Fund Awards – performance that is well above average doesn’t stay there forever; it usually comes back to earth.
This morning’s Report on Business features three pages on this year’s Lipper fund awards. Lipper, a division of Thomson Reuters, honors funds and fund management firms that have “excelled in consistently strong risk-adjusted performance, relative to their peers in 17 countries.”
Before purchasing any of the funds included in this list, investors should first understand the concept of regression to the mean.
Regression to the mean refers to the tendency for things to even out over time. It is a statistical phenomenon that can make natural variation in repeated data look like real change. It happens when unusually large or small measurements tend to be followed by measurements that are closer to average.
For folks who are not math wizzes, we can think of it this way: performance that is well above average usually doesn’t stay there forever; it usually comes back to earth. Performance that is well below average often gets better.
A great illustration of regression to the mean is the so-called ‘Sports Illustrated Jinx’, an urban myth that suggests that a disproportionately large number of the stars that appear on the cover of the famous magazine go on to suffer a decline in their fortunes.
This has nothing to do with jinxes, but can be explained by regression to the mean. A large number of cover stars should be expected to fall from their giddy heights, as the performances that led to their feature are extremes from which they should statistically be expected to regress.
Gamblers tend to ignore regression to the mean. If they win a few hands, they think they are ‘hot’, or more foolishly that they have superior skills. They keep playing until their winnings and their initial stake are gone. Sadly, too many investors do the same thing by placing big bets on last year’s hot fund or star manager.
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