Past performance is indicative of future results

At least when it comes to fund flows. Every fund manager knows that investors, and retail investors in particular, are sensitive to past performance. Underperform for long enough and outflows will happen. Outperform long enough and inflows will come as well. In the past, I have written about the awful performance chasing behaviour of pension funds. But what about retail investors?

Chandra Sekhar Mangipudi examined flows from retail investors but differentiated between outflows and inflows to check if there are any differences in performance sensitivity. The chart below shows the sensitivity of inflows and outflows to past returns of a fund going back 5 years. I only show sensitivities that are statistically significant.

Sensitivity of retail fund flows to past performance

Source: Mangipudi (2024)

The interesting observation is that past performance does not matter the same way for outflows as it does for inflows. First, the absolute value for the coefficients tends to be higher for inflows than for outflows and starts to drop off after month 12. This simply indicates that investors are performance chasers and focus in particular at the last 12 months. If a fund manager had a good year, the subsequent inflows will be larger than if the same fund manager just had a bad year.

Second, note how the lookback period for inflows is longer (about 52 months) than for outflows (about 36 months). This indicates that retail investors are willing to invest in funds if they had good performance three to five years ago but ignore bad performance from three to five years ago. In other words, retail investors are chasing the hope that a fund might have good performance if at any point in the last five years the fund can point to a sustained period of solid performance. Meanwhile, if a fund had poor performance in the more distant past, retail investors don’t seem to worry about that a lot. Instead, they simply sell a fund after an extended period of recent underperformance and then don’t look back.

And if you are wondering if that behaviour is in any way performance enhancing for retail investors, I can confirm your suspicions. Of course, this is suboptimal behaviour. Mangipudi finds that simply looking at last month’s performance of a fund leads to better fund selection than the observed pattern.