It’s the rare money manager that can beat the market year in and year out over a prolonged period of time. But it seems even remarkable specimens have a hard time sustaining the magic. A look back at past winners of Investment Executive’s Fund Manager of the Year award shows that the law of averages catches up with the best of them.

IE has paid tribute to the top-performing fund manager each year for more than a decade. Our selection criteria weed out managers that outperform spectacularly over the short-term, then flame out just as quickly. Instead, we consider only managers with 10-year records. And we look for managers that produce consistent positive returns year after year, beating their benchmarks — and their peer group — for most of the 10-year period.

Very few fund managers meet these standards. And although we have had only one repeat winner (Vancouver-based Phillips Hager & North Investment Management Ltd. in 1996, and again in 1998), often the same handful of names floats around the top of our list every year. They are the elite, at least in the eyes of the truly long-term investor.

Yet, a look back at these funds since we recognized their 10 years of outstanding performance suggests that few managers can sustain this type of success. For the most part, our past winners have been decidedly mediocre since taking MVP honours.

Collectively, the 10 funds that were winners in previous years have 55 years of post-MVP returns to study. For example, last year’s winner has one year of returns to look at, 2003’s winner has two years, and so on. Of those 55 reporting periods, the honoured funds have only managed to register in the first quartile 13 times, according to data supplied by Morningstar Canada. These funds spent slightly less time, 11 periods, all the way down in the fourth quartile.

Their average quartile ranking over these 55 reporting periods is 2.4, suggesting that they were largely middle-of-the-pack performers for much of the time. Among them, they also had 14 periods when they produced a negative annual return.

Of the 13 periods in which these funds were still first-quartile performers, seven of those periods occurred in the first two years after they received the award. Four of them were first-quartile performers in the year after they were honoured, and only two of those carried that over into a second year of frontline performance.

All of this goes to prove what? Well, apart from highlighting how incredibly difficult it is for fund managers to outperform the market and their peers over the very long run, it also points to the risk inherent in manager turnover. Only four of the 10 individuals named as IE’s Fund Manager of the Year over the past 10 years are still at the helm of the fund that brought them that recognition. Of those four still running their funds, three were honoured in the past four years. Almost all of the older winners have since moved on.

For the recent winners, a couple of years of post-win performance is not long enough to judge whether they can sustain their once-stellar track records into a second decade. For one thing, given that we think it prudent to look at fund managers’ track records over 10 years, it’s hardly fair to judge their post-award performance after just one or two years.

Markets can be fundamentally mispriced for a prolonged period, such as during the tech boom of the late 1990s. And, particularly in a relatively narrow market such as Canada’s, if you miss one sector call, you could easily lag the market for quite some time. Any fund manager who has missed out on energy stocks in the past year, for instance, is probably well behind the market. In the mid-1990s, it was crucial to be in financials. Over time, though, these sorts of anomalies even out and the best managers should ultimately be vindicated.

For the earlier award winners, for which we have a larger, more useful sample of performance data, most of the people running the funds that once knocked the cover off the ball for at least 10 years straight have moved on. Our research indicates that their replacements have had a hard time replicating their predecessors’ outstanding performance.

@page_break@This hints at just how rare and valuable a superior fund manager can be. As much as fund companies try to build management teams and investment processes into which new managers can be plugged, it appears it is very difficult to be successful. While most managers have some sort of team behind them, this doesn’t assure continuity.

Inevitably, individual managers develop their own theories and tendencies and may be willing to deviate from the predecessor’s discipline. Indeed, they may feel compelled to do so to distinguish themselves from a particularly successful forerunner, or in a vain effort to beat their benchmark by an increasingly wide margin.

However, this would seem to run contrary to some of the academic literature on evaluating fund managers. A paper published by the U.S. National Bureau of Economic Research in December 2002, entitled Judging fund managers by the company they keep, by Randolph Cohen, Joshua Coval and Lubos Pastor, found that a fund manager’s skill can be predicted by how well his or her portfolio mimics those of already successful managers.

The theory is that the more highly skilled managers will obtain useful information about securities ahead of others, that they will interpret widely circulated information in a similar way, and so, ultimately, make similar trades. If that’s true, young managers who learn at the knees of the rare, highly successful managers may do better to imitate their elders than to try to make a name for themselves.

As the saying goes, “past performance is no guarantee of future returns.” Unfortunately, that appears to be true even for funds that have great track records of consistent outperformance over long periods of time. IE