When investors structure and diversify their equity portfolios, a key reference is the value/growth style framework that has dominated the fund industry for decades. Once target allocations are set, investors then select the funds offering the most appropriate risk and reward characteristics. When investors evaluate individual funds, it is only natural that one consideration is historical performance against a benchmark or a peer group, where funds are compared to others with a similar style. As we all know, even a short spell of underperformance can get a fund manager fired or a fund closed down. Arguably, one knock-on effect is that fund managers become more short-term in their thinking, and are more tempted to invest in recently outperforming stocks.
However, there is a wealth of literature warning against short-term performance chasing. Most investment professionals will probably agree that it makes no sense to sell one fund – or stock – after a short period of underperformance, only to jump into another one with a better short-term return. Whether selecting funds or stocks, performance chasing often damages long-term returns. Yet in reality, it is quite common, and leaves many investors underexposed to whatever underperformed recently.
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