From Barry Ritholz:
The front page of yesterday’s Wall Street Journal called out mutual-fund analytics firm Morningstar and its five-star rating system.
The Journal’s conclusion? Top-rated funds “drew the vast majority of investor dollars, but most didn’t continue performing at that level.” Morningstar, of course, said “its ratings were not supposed to be predictive and they should be a starting point for investors selecting funds.”
….Retail and professional investor alike seem to ignore the fact that every single document ever generated by any investment-related firm has a warning on it to the effect that “Past performance is not an indicator of future returns.” Every chart ever drawn, each investing idea back-tested and every single historical comparison is testament to how little mind humans pay to that disclaimer.
To borrow from and paraphrase the Bard, the fault lies not in the stars, but in ourselves…..
To be fair to investors, Morningstar’s star system is supposed to be more than a rating of past performance. It should also reflect an assessment of whether a fund or company is likely to repeat that performance. That requires more in-depth analysis than just measuring past returns, whether earnings or the stock price.
At the same time, investors need to beware of basing long-term investment decisions on past performance. Instead focus on expense ratios for funds, profit margins for companies, and their positioning to take advantage of long-term structural trends in the global economy.