Morningstar recently found that nine of the top 10 stock funds over the past 24 months are one star rated funds. This is Morningstar's lowest rating in its five star scale. The system considers historical returns and risk.
What are we to make of this? Did the managers of these funds find some new method to dramatically improve their performance? Are there new managers running these funds? Were these funds in sectors that suffered poor performance in past years? Were the fund managers, among the thousands of funds tracked by Morningstar, just lucky after a stretch of bad luck?
There is probably no way to know for sure. But my first thought is of "reversion to the mean." This is the theory that performance eventually moves back to the mean or average. These top stock funds had performed well below the mean for several years. Perhaps they were simply due for a correction back to the mean.
We have recently seen this phenomenon with one highly acclaimed fund manager. Legg Mason's Bill Miller bet aggressively on financial stocks during the recent economic crisis. Unfortunately, the financial sector suffered massive losses and Miller's fund took a beating. As a result, his overall performance went from stellar to dismal. Recently, however, Miller's fund has recovered and is among the strongest performers in the past 2 years.
Again, I ask , is it luck or is it skill?
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