On the Return Persistence of Index and Nonindex Mutual Funds

This article deals with investment decision-making in the environment of the semi-persistent returns of active and passive funds. The author constructs a theoretical model of portfolio allocation between these two groups based on short- and long-term past returns and confirms its validity with a simulation based on a sample of US large-cap equity funds from 1990–2021. The analysis shows that short-term persistence in fund returns is limited and long-term performance is a significantly better predictor of future returns. It also points to a higher prevalence of passive instruments in long-term portfolios. This phenomenon is consistent across all types of time periods. Finally, the author proposes a return continuity indicator (RCI) as a simple tool to assess the persistence of (excess) return among actively managed funds.